Lenders worry about accelerated or strategic default because their behavior encourages it. As lenders allow more borrowers to live for free, more borrowers will opt to do so.
By DAVID STREITFELD
Published: July 8, 2010
LOS ALTOS, Calif. — No need for tears, but the well-off are losing their master suites and saying goodbye to their wine cellars.
The housing bust that began among the working class in remote subdivisions and quickly progressed to the suburban middle class is striking the upper class in privileged enclaves like this one in Silicon Valley.
Whether it is their residence, a second home or a house bought as an investment, the rich have stopped paying the mortgage at a rate that greatly exceeds the rest of the population.
More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic.
By contrast, homeowners with less lavish housing are much more likely to keep writing checks to their lender. About one in 12 mortgages below the million-dollar mark is delinquent.
This article has a seriously flawed assumption: debt is wealth. 
Rich people are not defaulting on their loans. Most truly rich people don't have home loans. It is the over-leveraged posers who have loans over $1,000,000. In fact, since the home mortgage interest deduction is capped at $1,000,000 the only reason someone would borrow that much is because they aren't rich. Also, contrary to popular belief, it isn't sophisticated financial management to carry leverage on a personal residence. Smart rich people don't do that. Dumbass posers do.
The owners of today's featured property undoubtedly felt rich when they borrowed $1,460,000. Now that they are living in a rental, they probably don't feel quite so wealthy and sophisticated.
Though it is hard to prove, the CoreLogic data suggest that many of the well-to-do are purposely dumping their financially draining properties, just as they would any sour investment.
“The rich are different: they are more ruthless,” said Sam Khater, CoreLogic’s senior economist.
The delinquency among large loan owners is not a sign of the rich being ruthless, it is a sign of the pretenders getting wiped out by a weak economy and the huge debt-service payments on their borrowed lives.
Five properties here in Los Altos were scheduled for foreclosure auctions in a recent issue of The Los Altos Town Crier, the weekly newspaper where local legal notices are posted. Four have unpaid mortgage debt of more than $1 million, with the highest amount $2.8 million.
Not so long ago, said Chris Redden, the paper’s advertising services director, “it was a surprise if we had one foreclosure a month.”
If you look at the chart provided to the New York Times by CoreLogic, the rich posers have been defaulting just like their subprime brethren, but lenders have opted not to foreclose on this group because they know what it will do to prices -- and the associated bank losses.
The sheriff in Cook County, Ill., is increasingly in demand to evict foreclosed owners in the upscale suburbs to the north and west of Chicago — like Wilmette, La Grange and Glencoe. The occupants are always gone by the time a deputy gets there, a spokesman said, but just barely.
In Las Vegas, Ken Lowman, a longtime agent for luxury properties, said four of the 11 sales he brokered in June were distressed properties.
“I’ve never seen the wealthy hit like this before,” Mr. Lowman said. “They made their plans based on the best of all possible scenarios — that their incomes would continue to grow, that real estate would never drop. Not many had a plan B.”
Speculative bubbles are a form of mass insanity where everyone ignores the obvious risks, and nobody makes a plan B. Paradoxical as it may sound, that is one of the reasons these things blow up. Whichever way the herd moves, the market is sure to move counter to it.
The defaulting owners, he said, often remain as long as they can. “They’re in denial,” he said.
Some are in denial, but many have accepted their fate and gaming the system.
... Lenders are fearful that many of the 11 million or so homeowners who owe more than their house is worth will walk away from them, especially if the real estate market begins to weaken again. The so-called strategic defaults have become a matter of intense debate in recent months.
Fannie Mae and Freddie Mac, the two quasi-governmental mortgage finance companies that own most of the mortgages in America with a value of less than $500,000, are alternately pleading with distressed homeowners not to be bad citizens and brandishing a stick at them.
Yep: Fannie Mae Encourages Strategic Default by Reducing Punishment Time for New Loan and Fannie Mae Bluffs Strategic Defaulters with Empty Threats. There appears to be no coherent policy at the GSEs, nor is there likely to be as long as politicians control them.
In a recent column on Freddie Mac’s Web site, the company’s executive vice president, Don Bisenius, acknowledged that walking away “might well be a good decision for certain borrowers” but argues that those who do it are trashing their communities.
The "trashing their communities" argument is silly. Houses change occupancy all the time without disruption to the community. Accelerated default may harm property values, but other than remaining owner's fantasies, and lenders' balance sheets, nothing changes. It angers me when lenders resort to childish peer pressure to keep people paying onerous mortgages.
The CoreLogic data suggest that the rich do not seem to have concerns about the civic good uppermost in their mind, especially when it comes to investment and second homes. Nor do they appear to be particularly worried about being sued by their lender or frozen out of future loans by Fannie Mae, possible consequences of default.
The delinquency rate on investment homes where the original mortgage was more than $1 million is now 23 percent. For cheaper investment homes, it is about 10 percent.
OMG! Those numbers are a catastrophe.
With second homes, the delinquency rate for both types of owners was rising in concert until the stock market crashed in September 2008. That sent the percentage of troubled million-dollar loans spiraling up much faster than the smaller loans.
“Those with high net worth have other resources to lean on if they get in trouble,” said Mr. Khater, the analyst. “If they’re going delinquent faster than anyone else, that tells me they are doing so willingly.”
This guy simply doesn't get it. THESE PEOPLE ARE NOT RICH: THEY ARE POSERS!
There are some truly wealthy people defaulting on mortgages because it is a wise business decision for them, but the vast majority are simply pretenders who couldn't make the payments if they wanted to.
Willingly, but not necessarily publicly. The rapper Chamillionaire is a plain-talking exception. He recently walked away from a $2 million house he bought in Houston in 2006.
“I just decided to let it go, give it back to the bank,” he told the celebrity gossip TV show “TMZ.” “I just didn’t feel like it was a good investment.”
The rich and successful often come naturally to this sort of attitude, said Brent T. White, a law professor at the University of Arizona who has studied strategic defaults.
“They may be less susceptible to the shame and fear-mongering used by the government and the mortgage banking industry to keep underwater homeowners from acting in their financial best interest,” Mr. White said.
Dr. White gets it.
... In the middle of a workday, one troubled homeowner here leaned over his laptop at the kitchen table, trying to maneuver his way out from under his debt and figure out the next big thing.
His five-bedroom house, drained of hundreds of thousands of dollars of equity over the last 13 years, is scheduled for auction July 20. Nine months ago, after his latest business (he has had several) failed in what he called “the global meltdown,” the man, a technology entrepreneur, said he quit making his $9,000 monthly payments.
“I’m going to be downsizing,” he said.
The man spoke on the condition of anonymity because, he said, he did not want his current problems to interfere with his coming reinvention. “I’m a businessman,” he explained. “I have to be upbeat.”
Ahhh the schadenfreude....
Lenders cause defaults by allowing borrowers to squat
The uproar over what lenders call strategic default (and I call Accelerated Default: What Strategic Default Really Is) centers around one key idea: borrowers won't repay loans if they don't fear foreclosure. Lenders created their own moral hazard when they chose not to foreclose on delinquent borrowers. Did they really think the word wouldn't get out?
Once people see their neighbors stop paying their mortgages and stay in their houses, they get angry. If those who are paying are struggling themselves, they start to feel foolish for being a chump. People won't endure much hardship when they believe they don't have to. Put yourself in their shoes: if you knew you could quit making your housing payment (rent or mortgage) and you wouldn't have to move, would you keep paying?
Squatting causes strategic default. That moral hazard cannot be avoided. Lenders cannot simply wait out the bad times and let people squat without having millions of other borrowers quit paying. I am amazed lenders thought they could allow squatting without consequence. They were tragically mistaken.
Option ARM Implosion
- This property was purchased on 11/17/2005 for $1,825,000. The owners used a $1,460,000 Option ARM from WAMU and a $365,000 down payment.
- On 10/10/2006 they opened a HELOC for $240,000. For their sake, I hope they maxed it out and got some of their down payment back.
- They got to squat for about 18 months.
Foreclosure Record
Recording Date: 07/14/2009
Document Type: Notice of Sale
Foreclosure Record
Recording Date: 04/07/2009
Document Type: Notice of Default
Irvine Home Address ... 24 PISMO Bch Irvine, CA 92602 
Resale Home Price ... $1,499,000
Home Purchase Price … $1,147,500
Home Purchase Date .... 6/10/2010
Net Gain (Loss) .......... $261,560
Percent Change .......... 22.8%
Annual Appreciation … 367.6%
Cost of Ownership
-------------------------------------------------
$1,499,000 .......... Asking Price
$299,800 .......... 20% Down Conventional
4.61% ............... Mortgage Interest Rate
$1,199,200 .......... 30-Year Mortgage
$296,749 .......... Income Requirement
$6,155 .......... Monthly Mortgage Payment
$1299 .......... Property Tax
$100 .......... Special Taxes and Levies (Mello Roos)
$125 .......... Homeowners Insurance
$142 .......... Homeowners Association Fees
============================================
$7,821 .......... Monthly Cash Outlays
-$1439 .......... Tax Savings (% of Interest and Property Tax)
-$1548 .......... Equity Hidden in Payment
$518 .......... Lost Income to Down Payment (net of taxes)
$187 .......... Maintenance and Replacement Reserves
============================================
$5,539 .......... Monthly Cost of Ownership
Cash Acquisition Demands
------------------------------------------------------------------------------
$14,990 .......... Furnishing and Move In @1%
$14,990 .......... Closing Costs @1%
$11,992 ............ Interest Points @1% of Loan
$299,800 .......... Down Payment
============================================
$341,772 .......... Total Cash Costs
$84,900 ............ Emergency Cash Reserves
============================================
$426,672 .......... Total Savings Needed
Property Details for 24 PISMO Bch Irvine, CA 92602
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Beds: 4
Baths: 3 full 2 part baths
Home size: 3,900 sq ft
($384 / sq ft)
Lot Size: 9,391 sq ft
Year Built: 2000
Days on Market: 15
Listing Updated: 40358
MLS Number: P741000
Property Type: Single Family, Residential
Community: Northpark
Tract: Cmbr
------------------------------------------------------------------------------
Model perfect home in the guard gated community of Northpark. This Spanish Colonial style home is highly upgraded and features 4 spacious bedrooms, 4.5 baths, and an executive office off of the luscious landscaped courtyard. Fabulous chef's kitchen with s/s appliances,Sub-Zero built-in refrigerator ,elegant granite,breakfast bar and butlers pantry. Gorgeous master suite and bath with large walk-in closet. Entertainer's dream backyard with pool and waterfalls, spa,and built-in BBQ center. This home sits on one of the largest lots in the community and resides right across from the large common area.
The flipper will make a fortune
I was at the auction on June 10 when this property was purchased. It was the first property that will require financing over the conforming limit that has gone to auction in Irvine in quite some time. I expected it to be postponed at the last minute. When the bidding started, the young man who bought the place bid $1 over the opening bid of $1,147,500. It must have been hard for him to contain his excitement when nobody bid him up.
This property sold for $1,825,000 back in 2005, and he bought it for $1,147,501 at auction. Assuming it has dropped 20% from the peak, it is still worth $1,460,000. Any way you look at it, this will be a home run.
It is risky. It may be difficult to sell because jumbo financing is still very hard to come by, and there is much competition at the higher price points, but still... he has plenty of room to lower his price and get out with a hefty profit.
I can see why people are forming funds to buy trustee sales and flip them. It is a lucrative business, and there is no shortage of properties in the foreclosure pipeline.
As many of you know, we launched a trustee sale business earlier this year helping individuals buy and sell trustee sale properties. If you would like to learn how you can get involved with trustee sales, please contact me at sales@idealhomebrokers.com.
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