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Borrowers Paying Large Mortgages Hinder Economic Recovery

Posted: 03 Nov 2010 03:30 AM PDT

People who continue to pay bloated mortgages with onerous debt-to-income ratios are slowing the economic recovery.

Irvine Home Address ... 5092 CINNAMON Irvine, CA 92612
Resale Home Price ...... $425,000

Forgotten lies aim to distnact me
This moon-mind must not connect
Pure nature will contain me
Freefall in air I will surpass
When I'm falling, calling, I return
Floating closer to your shore
I start to drift with the tide
Maybe I'll reach, I'll reach the beach
The Fixx -- Reach the Beach

Milllions of loan owners struggle to stay afloat. Many persist like a shipwreck suvivor clings to a makeshift raft hoping and praying they will reach the beach.

Back in March, I asked the question Why Do Struggling Homeowners Keep Paying Their Mortgages? and recently we looked at What Really Prompts Borrowers to Accelerate Their Default? Today, we examine the economic impact of the underwater loan owners "doing the right thing" by continuing to pay their oversized mortgage.

Millions of homeowners keep paying on underwater mortgages

The payments absorb billions of dollars that might be used for other forms of consumer spending, creating a drag on the overall economy.

By Don Lee, Los Angeles Times

November 1, 2010

For almost two years, home foreclosures have swept the nation, spreading misery among once-buoyant families, spattering lenders with red ink and undermining efforts to restart the economy.

But a bigger problem may turn out to be the millions of Americans who are still faithfully paying their mortgages, but on houses worth far less than before the bubble burst. It's not that these homeowners will stop making their payments. It's just the opposite — that they will keep doing it.

How could that be a source of future trouble? Because, with home prices stagnant in much of the country, payments on mortgages that are underwater could absorb billions of dollars that might be used for other forms of consumer spending — a drag on family finances, the housing market and the overall economy.

A refresher from California Personal Finance: Ponzi Style:

"Examine the graphic above. The first column shows a graphical breakdown of the income of a typical homeowner. Total home related debt (including taxes, insurance, HOA and other monthly expenses) is limited to 28% of gross income. Consumer debt including all other debt service payments is limited to 8%. Taxes take up about 24% (depending on income and tax bracket), and the remaining 40% is disposable income to cover the other expenses of daily life.

The second column shows what happens as people start to stretch to buy a home in a financial mania (charts are below). The increasing home debt reduces the tax burden a little, but the increased consumer spending and home debt takes a big chunk out of disposable income. The recession of the early 90s lingered for so long here in California because the people who bought in the frenzy of the late 1980s found themselves with crushing debts and greatly reduced disposable income. Prior to the increase in housing debt, this disposable income would have been spent in the local economy; instead, this money was sent out of state to the creditor who made the loan.

The big financial innovation--if you want to call it that--of the Great Housing Bubble was the nearly unrestricted use of cash-out refinancing and HELOCs to tap into home price appreciation. The third column shows the impact this new source of credit had on personal income statements. HELOC money allowed people to pay off their consumer debt while only modestly increasing their home debt. Since this income was untaxed (borrowed money is not truly income), the extracted money was entirely converted to disposable income. This incredible influx of disposable income caused our economy to explode.

Unfortunately, as is documented in the post Our HELOC Economy, the loss of this HELOC income is having devastating effects on local tax revenues and our economy. When you examine the personal income statements of borrowers in column four, you see that home debt and consumer debt have now become so burdensome that there is no longer enough disposable income to cover life's basic needs; borrowers are insolvent.

The only solution to the problem of borrower insolvency is a monumental restructuring of both home and consumer debt. Realistically, the only way this is going to occur is through foreclosure and bankruptcy. We are not going to re-inflate this Ponzi Scheme because when sustainable loan terms are applied to real incomes, people cannot raise bids to sustain or inflate home prices--even with 4.5% interest rates. Without home price appreciation and subsequent HELOC borrowing, the Ponzi Scheme does not work.

The implications of this are clear; we are going to experience an extended recession bordering on depression here in California that is going to linger for many, many years. During this extended crisis, a significant percentage of California homeowners are going to face foreclosure and personal bankruptcy.

The collapse of a Ponzi Scheme is never pleasant, and that is what we are facing. According to Arthur Miller, “An era can be said to end when its basic illusions are exhausted.” The unsustainable lifestyles and illusions of wealth created during The Great Housing Bubble are exhausted; the era has ended."

Back to the LA Times article:

And the drag could persist for years.

Of the estimated 15 million homeowners underwater, about 7.8 million owed at least 25% more than their properties were worth in the first quarter of this year, according to Moody's Analytics' calculations of Equifax credit records and government data.

More than 4 million borrowers, including 672,000 in California, 424,000 in Florida and 121,000 in Illinois — three of the biggest real estate markets — were underwater more than 50%. Their average negative equity: a whopping $107,000.

Many of these homeowners are paying much higher interest rates than the latest national average of 4.25%. They still have jobs and can afford to make the payments.

But they can't refinance because they owe too much. That home equity line of credit isn't going to happen. Even ordinary loans may be impossible to get. And selling the home at a huge loss is out of the question.

Nor can most underwater borrowers take advantage of the Treasury Department's loan-modification program, which generally requires a job loss or another kind of hardship.

In other words, they're stuck.

The individual loan owners and stuck, and the California economy is stuck because The California Economy Is Dependent Upon Ponzi Borrowers. With the various Ponzi loans being withdrawn from the market, California houses are no longer a viable source of spending money. We may maintain a significant amount of air in the housing bubble here because the Desire for Mortgage Equity Withdrawal Inflated the Housing Bubble, and this same desire will work to sustain it. Most loan owners in California view home price appreciation as an entitlement they can spend at will.

Heather Hines and her husband reflect this new reality. They owe $415,000 on a Santa Rosa, Calif., town house they bought in 2004 for $430,000. When the county appraised the three-bedroom home a few weeks ago, it was worth $246,000 — even less than a year earlier.

The couple had planned to move to a larger home after their two grade-school children became teenagers, but now that looks impossible. Their house needs a new roof, but they've put off replacing it for more than a year.

They did not budget for later home improvements because they expected the house to pay for itself. The appreciation was supposed to appear by market magic, and they would then borrow the money -- at ever decreasing interest rates -- to fix that roof. The best laid plans of mice and men often go astray.

"It's hard to think of making that investment when you're hundreds of thousands underwater," said Hines, 37, a city planner who like her husband is employed and has an advanced university degree. "It just feels hopeless. What are we supposed to do? It feels like we're never going to see any equity in our home."

They should feel that hopeless. Unless the Fed can print enough money to put everyone back to work and stimulate some major wage inflation, house prices are not going to regain their former peaks any time soon.

Theoretically, the Hineses could walk away — stop making the mortgage payments that consume a big part of their income. But defaulting would ruin their credit and have other negative consequences. So, she said, they'll keep paying and hoping for the best.

Hope is not a plan.

Unhappily for the rest of the country, that's not the end of the problem: The Hineses' financial bind will ripple throughout their community and the larger economy.

The real estate market depends on such homeowners being able to sell and move up; without them the trade-up market can't grow.

This is an under-appreciated feature of the housing market. When the government manipulations put in a temporary bottom at an elevated price point, they delayed the bottoming of the market. If the market had been allowed to crash and bottom in 2011, move-up buyers would have started becoming active by 2013, and the rate of sales would increase with the new influx of equity from appreciation. With all the government manipulation, we have elevated the bottoming price, but delayed the bottom for two or three years. The impact of that will be apparent over the next several years as the market drags along the bottom and few obtain any equity to simulate a move-up market.

Meantime, the Hineses will keep delaying that new roof, depriving a local roofer of business. They're unlikely to redecorate or upgrade the kitchen either, as millions of families were doing before the recession — more potential losses for local businesses, not to mention the car dealers, clothing and consumer electronics stores and manufacturers of the products that the Hineses won't buy.

Weighed down by the huge debt on their house, they also will be a lot more cautious about how they use credit cards. Big family getaways in the summer? Forget it, Hines said.

Multiply such sentiments by millions across the country and that translates into lackluster private spending, which accounts for 70% of the American economy.

"Families have not yet boosted their spending above the levels preceding the severe cuts they made during the recession," William Dudley, president of the Federal Reserve Bank of New York, said in a speech last month.

"This frugality stands in stark contrast to the first year of recovery from previous deep recessions," Dudley said.

This frugality will be long lasting. With the debt orgy we just witnessed, many are shunning debt in favor of a lifestyle of prudence and saving. Contrary to popular belief among economists, frugality and savings are good for the economy as people can invest in productive activities and assets instead of mindlessly consume.

In prior downturns, the housing industry and consumer spending powered the economy back to strength. Home building not only created construction and finance jobs but also fueled manufacturing of glass and lumber, furniture and appliances, and a host of other goods and services.

In normal times, the U.S. should be putting up about 1.7 million new houses annually, but this year it's running at about 600,000, economist David Crowe of the National Home Builders Assn. said. He thinks it will be three years before home building returns to its potential.

From what I am observing with the building industry here in California, we are coming out of the double dip, and activity is beginning to pick up again. Developers and builders are out working on land projects again preparing for the next cycle. Of course, this new activity is minor compared to the activity in 2005, but it feels like a boom compared to 2008 and 2009.

Rather than going out on their own or starting families, young Americans are doubling up with friends and relatives, saving more and paying down debts. Older Americans are staying in their jobs longer, hoping that the single biggest asset for most of them, their homes, will recover in value.

But nobody is expecting a return of rapid real estate appreciation any time soon.

Except here in California where everyone thinks the bottom is formed and the new party is about to begin.

If home prices were to rise at an annual rate of 3%, not an unlikely scenario, it would take the Hineses about 11 years to get to a point where their mortgage balance was even with their property value.

Refinancing the Hineses' 6.5% interest loan could be a big help, saving them almost $600 a month. But lenders won't even consider them.

And unless borrowers fall behind on their mortgage payments or face a high risk of defaulting, there's little chance that lenders, even with federal incentives, would reduce their principal or lower their interest rates.

"They feel completely left out," said Fred Arnold, past president of the California Assn. of Mortgage Professionals, referring to many underwater borrowers.

"If you stop payments, you have a much better chance of getting a modification," Arnold said.

Given these truths, is it surprising that some many mortgage loans are delinquent?

He contends that the federal government should set aside funds to help more borrowers refinance: "It would put immediate money into the economy." But that's not in the cards, especially with budget deficits weighing on Washington and the American public.

Eventually, economists suggested, a lack of options will push more underwater borrowers to walk away from their mortgages. But in the meantime, the stress on families, the housing market and the whole economy will continue.

Fix the Housing Market: Let Home Prices Fall. We will not see significant economic improvement until the housing market is allowed to bottom naturally -- a process finally possible now that some of the more overt government market manipulations of interest rates and tax incentives has expired. Eliminating Government Housing Subsidies Will Improve the Economy. 

Mike Saint-Just, 62, doesn't see a lot of room to maneuver. In 2007, he put down $125,000 on a $230,000 one-bedroom condominium near Palm Springs. County tax authorities say it is now worth $87,000.

After tapping a home equity line of credit, Saint-Just owes $143,000 — about two-thirds more than the value of his home.

Saint-Just draws a federal pension, enough to stay current on his loan but not much more. When he asked his lender about getting a new loan with lower rates, he said he was told he was too far underwater.

The loan officer "did say I could go into foreclosure and hope, maybe, they might do something. And they might not, in which case my credit would be ruined and I'd be out the door of the unit," he said.

So Saint-Just keeps making his monthly payments and cutting back on nearly everything else.

"It means dropping grocery stores and going to Wal-Mart, the 99 Cents store for food and generic items," he said.

With the winter coming, he's preparing to dress warmly and wrap himself in a large afghan to save on heating. That may get Saint-Just through the cold weather, but it may leave the overall economy to shiver.

Those that continue to pay bloated mortgages damage the economy, and those that stop making payments stimulate the economy: Strategic Default: The $10,000,000,000 Monthly Economic Stimulus. So what do we make of that? Would a widespread loan owner revolt be a good thing for the economy?

They borrowed too much

Some people may have been able to afford their properties when they bought them, but then they simply over-borrowed and now they face losing their homes from excessive debt.

  • Today's featured property was purchased on 7/20/1998 for $237,500. The owners used a $190,000 first mortgage and a $47,500 down payment.
  • On 1/19/2001 they refinanced with a $305,000 first mortgage.
  • On 10/20/2004 they refinanced with a $388,500 first mortgage.
  • Total mortgage equity withdrawal is $198,500 including their down payment.

Foreclosure Record
Recording Date: 10/04/2010
Document Type: Notice of Rescission

Foreclosure Record
Recording Date: 09/29/2010
Document Type: Notice of Default

Foreclosure Record
Recording Date: 08/13/2010
Document Type: Notice of Default

Their recent notice of rescission suggests they just got a loan modification. The reality of their debts has prompted them to sell to get out from under the mortgage they can't afford. They already spent their profits on the deal, and now they are hoping they can escape without becoming another short sale. Their asking price gives them some room to maneuver, but not much.

Do you think they will get out without becoming a short sale?

Irvine Home Address ... 5092 CINNAMON Irvine, CA 92612

Resale Home Price ... $425,000

Home Purchase Price … $237,500
Home Purchase Date .... 6/20/1998

Net Gain (Loss) .......... $162,000
Percent Change .......... 68.2%
Annual Appreciation … 4.7%

Cost of Ownership
$425,000 .......... Asking Price
$14,875 .......... 3.5% Down FHA Financing
4.29% ............... Mortgage Interest Rate
$410,125 .......... 30-Year Mortgage
$81,027 .......... Income Requirement

$2,027 .......... Monthly Mortgage Payment

$368 .......... Property Tax
$0 .......... Special Taxes and Levies (Mello Roos)
$71 .......... Homeowners Insurance
$209 .......... Homeowners Association Fees
$2,675 .......... Monthly Cash Outlays

-$321 .......... Tax Savings (% of Interest and Property Tax)
-$561 .......... Equity Hidden in Payment
$23 .......... Lost Income to Down Payment (net of taxes)
$53 .......... Maintenance and Replacement Reserves
$1,870 .......... Monthly Cost of Ownership

Cash Acquisition Demands
$4,250 .......... Furnishing and Move In @1%
$4,250 .......... Closing Costs @1%
$4,101 ............ Interest Points @1% of Loan
$14,875 .......... Down Payment
$27,476 .......... Total Cash Costs
$28,600 ............ Emergency Cash Reserves
$56,076 .......... Total Savings Needed

Property Details for 5092 CINNAMON Irvine, CA 92612
Beds: 3
Baths: 2 baths
Home size: 1,539 sq ft
($276 / sq ft)
Lot Size: 1,500 sq ft
Year Built: 1974
Days on Market: 80
Listing Updated: 40473
MLS Number: S628876
Property Type: Condominium, Residential
Community: University Park
Tract: Tr
According to the listing agent, this listing may be a pre-foreclosure or short sale.

HUGE $50,000 PRICE REDUCTION!!! One of the most desireable neighborhoods in Irvine. The Terrace has it all. Expansive lighted greenbelts, tot lots, two pools, a clubhouse, walkways and its close to everything; shopping (walking distance to a Ralphs market), freeways, entertainment centers like The Spectrum and The District and so much more. This three bedroom home is a wonderful spacious floor plan with a large kitchen, dining area and a cozy living room with a fireplace. Good sized, fenced and private rear patio. The single story home is situated on a small cul de sac and has an oversized driveway. Its in Move-In condition, in a great location and ready for you and your furniture. Great starter home or an investment property. No Mello Roos and low HOA dues. Wonderful community. This short sale should go fast.


This short sale should go fast? When in the history of mankind has a short sale gone fast?

I bet they were surprised when they made their "HUGE $50,000 PRICE REDUCTION!!!" and no offers came in. The price has been reduced another $25,000 since then.

Date Event Price  
Oct 22, 2010 Price Changed $425,000  
Oct 13, 2010 Price Changed $450,000  
Sep 21, 2010 Price Changed $499,000  
Aug 13, 2010 Listed $549,900  
Jul 20, 1998 Sold (Public Records) $237,500  
Jun 22, 1995 Sold (Public Records) $180,000

Great starter home or an investment property. Starter home, maybe; investment property, not unless you are a fool.

real estate home sales


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