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Banks encourage strategic default by reducing FICO impact

Posted: 17 Dec 2010 02:30 AM PST

Banks are again encouraging strategic default with their policies. This time they are reducing the FICO score impact because they want to keep the credit card business going with strategic defaulters.

Irvine Home Address ... 8 CARMICHAEL Irvine, CA 92602
Resale Home Price ...... $790,000

This is a thing I've
never known before
It's called easy livin'
This is a place I've
Never seen before
Now I've been forgiven

Easy livin’ and I've been forgiven

Uriah Heep -- Easy Livin'

One of the major fears people have concerning acclerating their mortgage default is that they will be cut off from future borrowing by a lowered FICO score. This fear is important to the functioning of the system because if people do not fear the ramifications of default, many more will default, and bank losses will mount.

Back in April Io wrote Fannie Mae Encourages Strategic Default by Reducing Punishment Time for New Loan. Now, lenders are succumbing to pressures from the credit card side of their business to lessen the impact of mortgage delinquency. Will make enough on the credit cards to make up for what they will lose by encouraging strategic default?

Are Mortgage Defaulters Getting a Pass?

Posted by Stephen Gandel -- Tuesday, December 14, 2010 at 1:13 pm

It appears not paying your mortgage won't hurt your credit as much as you think.

The New York Times reports that banks, in an effort to boost their credit card business, are courting customers who decided to default on their home loans. So-called "strategic defaulters," who walk away from their mortgage loan because they owe more than their house is worth, are now apparently considered to be good potential customers. Voluntarily choosing foreclosures was once seen as financial suicide. It was assumed that banks would shun those that didn't end up paying back their home loans. But it turns out that was more of a threat by the banks. That's good news from the millions of Americans who are underwater on their homes. But if banks are truly giving strategic defaulters a pass that could lead to a new wave defaults, and more pain for their mortgage lending divisions and the housing market in general. This seems like another dumb move for the banks and for our economy. Here's why:

The banks' credit card businesses have taken a hit from the recession and new financial regulations. So they need new customers. The question is where will they get those customers. In the past two years, many people have had problems paying off their debt. Others are already over leveraged. So in that context it would seem that people who walked away from their homes would make good candidates to be new credit card customers. First of all, they could have kept paying their loans. Second, most strategic defaulters are now all of a sudden much more debt free, especially if they chose to become renters.  That may mean they are even a less risky borrower.

The truth is, strategic defaulters probably are better creidt risks after the default. It will be much easier for them to make payments once they don't have to pay the huge mortgage.

The problem is that while there have been a significant number of strategic defaulters, there are millions more who are underwater and still paying their mortgages. On Monday, research firm Corelogic reported that there are nearly 11 million homes around the country that are worth less what borrowers owe on those houses. That was down from a peak of 11.3 million homes in the beginning of the year. But it is still a lot. According to Corelogic, 22.5% of all homeowners with a mortgage are now underwater. Worse, home prices have started to fall again. If values were to drop another 5%, Corelogic estimates the number of borrowers who owe more than they own would jump 2.4 million.

Not all of these people will end up defaulting. Many borrowers, out of love for their house or obligation, will choose to continue to pay even if it makes more financial sense to walk away. Still, we have come a long when from the moral outrage that was once associated with walking away from your mortgage. And that makes sense to me. When a bank makes a home loan they should realize they are taking on real estate risk as well as credit risk. They share the risk of falling home prices along with the consumer. So individuals should have a right to stop paying on their mortgage if it will improve their finances. If banks want to keep them paying, they should have to offer incentives, like the very good Responsible Homeowner Reward Program.

I don't think banks should run special programs that encourage people to keep paying their debts. People should do that anyway. If they don't repay their debts, they are not extended credit in the future. Obtaining future credit is what motivated borrower behavior. People will do whatever they have to in order to obtain that next loan. Usually that means continuing to pay the last one.

Yet, I think shunning those customers that do end up walking away from their mortgages is a good thing as well, for the banks and for the economy. For the banks, even offering tacit approval for strategic defaulting seems like another dumb move. Even if many of the loans were sold off to investors, banks lose money when people stop paying their mortgages. And while I haven't done the numbers, my guess is that they would lose more money from the added defaults than they gain from the new card business.

Second, one of the problems that led to the financial crisis was too much risk. Strategic default should be one of the mechanisms that helps to deleverage the economy. But if the people who walk away from their mortgage just become the pool from which banks pitch high-cost credit cards, then financial healing process we need won't happen.

Lenders don't want to see deleveraging even if it sit he best thirng for our economy. The banks don't care about the economy. They only care about making the most money they can by keeping people in a state of indentured servitude. Bankers would be elated if people could borrow their way to prosperity and keep all their bad debt alive and active.

In many cases, second mortgage debt including old HELOCs simply become revolving credit debt that is no longer secured by real estate. Strategic defaulters opt to continue paying on second liens to keep access to the line of credit.

I agree with this author that the banks shouldn't be giving strategic defaulters access to easy credit so soon after the default. Word will get out, and people will have one less reason not to walk away from their mortgages.

Irvine Home Address ... 8 CARMICHAEL Irvine, CA 92602  

Resale Home Price ... $790,000

Home Purchase Price … $876,000
Home Purchase Date .... 4/26/2004

Net Gain (Loss) .......... $(133,400)
Percent Change .......... -15.2%
Annual Appreciation … -1.5%

Cost of Ownership
$790,000 .......... Asking Price
$158,000 .......... 20% Down Conventional
4.87% ............... Mortgage Interest Rate
$632,000 .......... 30-Year Mortgage
$161,165 .......... Income Requirement

$3,343 .......... Monthly Mortgage Payment

$685 .......... Property Tax
$267 .......... Special Taxes and Levies (Mello Roos)
$132 .......... Homeowners Insurance
$146 .......... Homeowners Association Fees
$4,572 .......... Monthly Cash Outlays

-$812 .......... Tax Savings (% of Interest and Property Tax)
-$778 .......... Equity Hidden in Payment
$296 .......... Lost Income to Down Payment (net of taxes)
$99 .......... Maintenance and Replacement Reserves
$3,376 .......... Monthly Cost of Ownership

Cash Acquisition Demands
$7,900 .......... Furnishing and Move In @1%
$7,900 .......... Closing Costs @1%
$6,320 ............ Interest Points @1% of Loan
$158,000 .......... Down Payment
$180,120 .......... Total Cash Costs
$51,700 ............ Emergency Cash Reserves
$231,820 .......... Total Savings Needed

Property Details for 8 CARMICHAEL Irvine, CA 92602
Beds: 3
Baths: 2 full 1 part baths
Home size: 2,249 sq ft
($351 / sq ft)
Lot Size: 3,701 sq ft
Year Built: 2001
Days on Market: 16
Listing Updated: 40522
MLS Number: C10124820
Property Type: Single Family, Residential
Community: Northpark
Tract: Cust
According to the listing agent, this listing is a bank owned (foreclosed) property.

BANK OWNED HOME!!! Beautiful Home in Highly Sought after Gated 'NORTHPARK' Community. Desirable Corner Lot Location! Home has 3 Bedrooms Plus Downstairs Office/Den that Could be Converted to 4th Bedroom. Tiled Entry/Living Room, Guest Bath Downstairs with Pedestal Sink, Open Modern Kitchen with Granite Countertops & Center Island with Space for Wine Refrigerator. Kitchen is Open to Family Room with Granite Fireplace, French Doors Open Up to Back Patio/Dining and Family Room Area, Spacious Master Suite with Walk In Closet and Dressing Area, Two Sinks Separated by Corner Bathtub with Tiled Floors in Master Bath. Upstairs Separate Laundry Room. Crown Molding and Ceiling Fans Included in this Exquisite Home! SUBMIT OFFERS BEFORE IT GONE!!!



I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.

Have a great weekend,

Irvine Renter

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