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Accelerated mortgage defaults likely choice to deleverage household debt

Posted: 24 Dec 2010 02:29 AM PST

Most economists agree that households will continue to deleverage. Bank of America believes over $1,000,000,000 will come from strategic default.

Irvine Home Address ... 65 GRANDVIEW Irvine, CA 92603
Resale Home Price ...... $2,320,000


In the town where I was born,
Lived a man who sailed to sea,
And he told us of his life,
In the land of submarines,

So we sailed on to the sun,
Till we found the sea green,
And we lived beneath the waves,
In our yellow submarine,

Beatles -- Yellow Submarine

Households likely to deleverage debt with underwater mortgage defaults: Report

by JON PRIOR -- Monday, December 20th, 2010, 11:02 am

Bank of America Merrill Lynch analysts said the most likely way households will deleverage roughly $1 trillion in excess debt is through the default of more underwater mortgages.

Home prices in the Standard & Poor's/Case-Shiller 20-city index have dropped 28.6% from the peak in the summer of 2006. This has led to more than 10.8 million homes, or 22.5% of the entire U.S. market in negative equity as of the third quarter, according to the analytics firm CoreLogic. And while that percentage is down from the 50 basis points from the previous quarter, negative equity remains the primary factor holding back a recovery in the housing market and the overall recovery.

Analysts said the collapse in home prices means the asset value supporting Americans' debt is no longer there.

Home values were an illusion created by excessive debt. Americans were offered free money for nothing more than owning a house. This made houses very desirable which prompted more buying and drove prices higher. As prices moved higher, banks were willing to give out more and more free money in order to entice Americans to buy more houses to get more free money.

It was a Ponzi scheme.

The collapse in values is simply a reversion to what prices would have been if we hadn't inflated a massive housing bubble.

"It’s the holidays and talk of deleveraging needs would appear to be sacrilegious or even un-American," BofAML analysts said. "Most of the deleveraging will come through default of underwater mortgages, although less consumption likely will be part of the equation as well."

But consumers are not alone. Excess debt is also an issue in municipalities and sovereign nations. Recent increases to interest rates will put more need for the U.S. to begin implement fiscal constraint.

"At a minimum, the vast amounts of excess debt permeating the developed economies will act as a drag on growth for some time," analysts said.

Of course there will be less consumption. We are no longer giving out hundreds of thousands of dollars of free money to Ponzis. Until we start doing that again, consumer spending will be down. Hopefully, we won't be giving Ponzis billions in tax subsidies and bailouts in the next cycle, but you never know.

An example of necessary deleveraging

Someone bought today's featured property with a great deal of debt. They have so much debt that they can't sell the house for more than the debt owed, and they can't rent it out for enough to cover the payments. This is a money pit. The original buyer is getting nothing out of the property. It doesn't appear as if this property was ever lived in. It looks like a purely speculative play on appreciation without regard to carrying costs.

This leverage has no support. The borrower isn't going to bleed cash every month to support an investment with no current value very long. A borrowers tolerance for negative cashflow is the strength of their kool aid intoxication about prices coming back. What loan owners have is an option position -- no current value but potential future value if prices rise -- hope and denial are what they cling to.

If prices stay down for a long period of time, distressed borrowers are bleeding cash every month for a reward that never comes. Their option position never gets back in-the-money.

A financial position taken by the herd -- many loan owners are underwater clinging to the hope of rising prices -- is self defeating. With so many anxious sellers waiting for some magic price point where they get out whole, the herd creates a buffer of overhead supply waiting to be absorbed at higher price points.

Some of the sellers can't wait because the distress is acute. Many of the borrowers who completed HAMP loan modifications still had 65% or greater back-end debt-to-income ratios after the modification. The debt distress will be worse for some than for others, but it will continue to shake out supply until the excess debt -- the debt not supportable by incomes -- is removed from the system.

I last profiled this property back when the asking price was $2,800,000.

Many nice tract-home neighborhoods became elevated to the $1,000,000 club by borrowed money. People used to sell their homes and port $500,000 in equity to buy a $1,100,000 home. During the housing bubble, they would borrow $2,000,000 with an Option ARM and push prices of homes up to the ridiculous prices we see today. The problem with this is simple: the debt buyers cannot be replaced with equity buyers. Some neighborhoods may survive, but the more debt a neighborhood has, the more it will fall -- when lenders finally get around to pushing out the squatters.

  • Today's featured property was purchased near the peak on 10/16/2006 for $3,518,000. The owners used a $2,814,167 first mortgage, a $351,771 HELOC, and a $352,062 down payment. Think about that -- these people only put about $350K of their own money in a $3.5M purchase.
  • On 12/8/2006 they obtained a HELOC for $356,078 to get access to their full down payment.
  • On 6/14/2007 they obtained a HELOC for $742,400.
  • Total property debt is $3,556,567
  • Total squatting time is at least 11 months.

Foreclosure Record
Recording Date: 04/06/2010 
Document Type: Notice of Sale  

Foreclosure Record
Recording Date: 09/24/2009 
Document Type: Notice of Default

Nice back yard....

Irvine Home Address ... 65 GRANDVIEW Irvine, CA 92603

Resale Home Price ... $2,320,000

Home Purchase Price … $3,518,000
Home Purchase Date .... 10/16/2005

Net Gain (Loss) .......... $(1,337,200)
Percent Change .......... -38.0%
Annual Appreciation … -7.9%

Cost of Ownership
$2,320,000 .......... Asking Price
$464,000 .......... 20% Down Conventional
4.87% ............... Mortgage Interest Rate
$1,856,000 .......... 30-Year Mortgage
$473,294 .......... Income Requirement

$9,816 .......... Monthly Mortgage Payment

$2011 .......... Property Tax
$583 .......... Special Taxes and Levies (Mello Roos)
$387 .......... Homeowners Insurance
$410 .......... Homeowners Association Fees
$13,207 .......... Monthly Cash Outlays

-$1699 .......... Tax Savings (% of Interest and Property Tax)
-$2284 .......... Equity Hidden in Payment
$869 .......... Lost Income to Down Payment (net of taxes)
$290 .......... Maintenance and Replacement Reserves
$10,382 .......... Monthly Cost of Ownership

Cash Acquisition Demands
$23,200 .......... Furnishing and Move In @1%
$23,200 .......... Closing Costs @1%
$18,560 ............ Interest Points @1% of Loan
$464,000 .......... Down Payment
$528,960 .......... Total Cash Costs
$159,100 ............ Emergency Cash Reserves
$688,060 .......... Total Savings Needed

Property Details for 65 GRANDVIEW Irvine, CA 92603  
Beds: 6
Baths: 4 full 3 part baths
Home size: 5,600 sq ft
($414 / sq ft)
Lot Size: 12,683 sq ft
Year Built: 2006
Days on Market: 6
Listing Updated: 40525
MLS Number: P762643
Property Type: Single Family, Residential
Community: Turtle Ridge
Tract: Lacm
According to the listing agent, this listing may be a pre-foreclosure or short sale.

Million $$ Views Luxury Estate - La Cima Model 1X on Single Loaded Street w Ocean/City Lights & Breathtaking Views * Welcome Entry Courtyard adjoints an Open Air Dining Loggia w Fireplace * 6 BR 6.5 BA + Hm Theater + Bonus Rm 4 Car Garage * Main Floor Master Suite * Complete Saparate Living Suite The Casita is a Private Oasis * 2nd Story Private Access to a spacious Living Rm w Open Kitchen * Super Launddry Rm * Lot of Custom upgrades

Launddry? Saparate?



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 and a joyous holiday,

Irvine Renter

real estate home sales


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