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The right-to-rent a foreclosure would encourage strategic default

Posted: 14 Apr 2011 03:30 AM PDT

The right-to-rent proposal floating around Washington would crash house prices as loan owners everywhere strategically default to lower their monthly payments and stay in their houses.

Irvine Home Address ... 40 DESERT WILLOW Irvine, CA 92606
Resale Home Price ...... $995,000

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Now your mom threw away your best porno mag (Bust it!)

You gotta fight for your right to party

Beastie Boys -- (You Gotta) Fight Your Right (To Party)

The idea of a right to rent has been floated by Dean Baker of the Center for Economic and Policy Research. His proposal is to give every loan owner the right to stay on in their foreclosure for five years paying market rents.

I first covered this issue in The Right to Rent Would Flatten the California Housing Market. I noted the following:

Dean Baker of the CEPR was one of the early public voices who called the housing bubble. He accurately noted the disparity between rent and payments and concluded housing prices were not sustainable. Like me, he was a renter looking to buy as prices were ramping up, and like me, he noted that since it didn't make sense for him personally to buy, it didn't make sense for anyone else either. Being an economist at an influential think tank, he was in a position to research and write about the issue and be heard.

I really like Mr. Baker's proposal, but I have been afraid to write about it because I don't think lawmakers fully understand what passing his legislation would do to the housing market. I would very much like to see it become law, but if it does, every inflated housing market in the country would crash very hard as loan owners accelerate their defaults.

My position on this issue hasn't changed. I would like to see it be made a policy because of the impact it would have on the housing market and the economy in the long term. Short term, it will crush the banks as the remaining inflated markets crash under waves of strategic default.

Commentary: Right-to-Rent Would Ease Foreclosure Mess

By Dean Baker -- April 11, 2011, 1:14 PM ET

Developments asked Dean Baker, co-director of the left-leaning Center for Economic and Policy Research in Washington, D.C., to weigh in on the housing market. Mr. Baker first proposed the right-to-rent idea in 2007.

While the rate of foreclosures may have finally peaked, it is not going to come down quickly. We are virtually certain to see at least a million foreclosures in 2011 and comparable numbers in 2012 and 2013. Many more homeowners will lose their homes through distressed sales.

This is a crisis for both the homeowners themselves and also for the communities where these foreclosures are concentrated. There is considerable research showing that foreclosed properties are a blight on neighborhoods, bringing down property values and creating eyesores and safety risks. For these reasons, there is a strong argument for taking measures to reduce the pace of foreclosures.

I think some of those arguments are spurious. In my opinion, foreclosure is the best form of principal reduction, and foreclosures are essential to the economic recovery. But assuming Dean Baker is right and
I am wrong, the impact of his proposal on the housing market would be catastrophic for lenders.

However, few would argue for yet another round of the federal Home Affordable Modification Program. HAMP has proven bureaucratic and ineffective. Only a small share of threatened homeowners have received permanent modifications and a large portion of this select group is expected to re-default.

I’ve said it before, and I’ll say it again: There is a simple alternative that involves no government money and no new bureaucracy. We could temporarily change the rules on foreclosure to allow homeowners the right to stay in their home as renters for a substantial period of time (e.g., 5 years) following a foreclosure.

During this period, they would pay the market rent as determined by an independent appraiser. They would have the same rights and responsibilities as other tenants, with the exception that they could not be evicted without cause. The lender would own the property and would be free to sell it, although the former homeowner would still have the right to remain as a tenant even if the home is sold.

If every loan owner in America had the right to stay in their current house and pay only market rents rather than an inflated house payment, then every underwater loan owner with a loan payment exceeding rent would have less of a dis-incentive to strategically default. The only thing stopping most loan owners from defaulting is the fact that they have to leave their houses when they do. If you take away that punishment, many more people will strategically default.

This policy accomplishes several important goals. First and foremost it provides housing security for homeowners who got caught up in the middle of the bubble. These people can be blamed for having made a mistake by buying homes at bubble-inflated prices. But this mistake is small compared with the mistakes made by the banks that made hundreds of billions of dollars of bad and often deceptive loans.

I agree with his assessment that banks made the bigger mistake and lenders are more culpable than borrowers when it comes to lending issues. However, borrowers can't be given a free pass if our system of lending is to function.

We were willing to give these banks trillions of dollars of loans at below market rates. Allowing foreclosed homeowners to stay in their homes as renters seems a rather small concession in comparison. This right-to-rent provision can also be narrowly structured so that it only applies to owner-occupied homes of less than the median value that were bought during the bubble years. This will ensure that it is not exploited by wealthy homeowners or investors.

I like that provision, but those just above the median won't feel quite as good about it. I am delighted that his proposal would not help HELOC abusers stay in their homes.

By changing the balance of power between lenders and homeowners, the right to rent provision would give lenders more incentive to voluntarily arrange modifications that allow homeowners to stay in their house as owners. This would be the best possible outcome.

The fact that foreclosed homes remain occupied will prevent the sort of neighborhood blight that has devastated many communities across the country. Tenants with security in their home will have an incentive to keep the property looking respectable.

I don't think that is true. Holdover owner tenants will not spend anything to maintain the property during the period of bank ownership. In fact, the tenant demands on the landlord for routine maintenance will undoubtedly get out of control. Loan owners will quickly realize they can have the benefits of renting (owner pays for maintenance) at a lower cost, and they will likely be given a chance to repurchase again in the future. Does anyone really think strategic default would not become the norm?

Finally, the right to rent could free up money that is currently going to mortgage payments on homes where owners never accrue any equity. In some of the former bubble markets the difference between mortgage payments on a house purchased near the peak of the bubble and the market rent can be more than $1,000 a month. The money saved by former homeowners is money they will spend in the communities where they live.

I argued the same in foreclosures are essential to the economic recovery. Californian's gain no long term benefit from making oversized mortgage payments. The money they currently send to a lender is a drain on the local economy. Only fresh borrowing and a return to Ponzi living can make the old system work.

So there you have it: A simple policy that requires no taxpayer dollars and no new bureaucracy.

I love his idea, but realistically, it will never happen because the resulting strategic default would make the foreclosure problem much worse for the banks. It would be a great thing for society because every inflated market would immediately crash down to cashflow levels and stay there. Lenders would be forced to limit house payments to comparable rents because that is all they can recover if the borrower defaults. The days of payments exceeding comparable rents would be over. I think that would be great.

Would the right-to-rent replace the choice-to-squat?

I first profiled today's featured property back in August of 2009 when it was a short sale advertised at $750,000. Even then I noted they had been squatting for a while.

Foreclosure Record
Recording Date: 08/25/2008
Document Type: Notice of Default

Not much has changed since then.

Foreclosure Record
Recording Date: 03/02/2010
Document Type: Notice of Sale

These owners have been squatting in this million dollar home for almost three years. Should we let them stay on for another 5 years at market rents?

I would rather see them move out so a family who can afford the property can move in. Just because a lander have them a dodgy loan and allowed them to occupy a property they cannot afford does not mean we should go to heroic efforts to keep them in a property while displacing a family who could legitimately afford it.

Irvine House Address ... 40 DESERT WILLOW Irvine, CA 92606 

Resale House Price ...... $995,000

House Purchase Price … $1,306,500
House Purchase Date .... 2/9/2006

Net Gain (Loss) .......... ($371,200)
Percent Change .......... -28.4%
Annual Appreciation … -5.2%

Cost of House Ownership
$995,000 .......... Asking Price
$199,000 .......... 20% Down Conventional
4.87% ............... Mortgage Interest Rate
$796,000 .......... 30-Year Mortgage
$180,432 .......... Income Requirement

$4,210 .......... Monthly Mortgage Payment
$862 .......... Property Tax (@1.04%)
$542 .......... Special Taxes and Levies (Mello Roos)
$207 .......... Homeowners Insurance (@ 0.25%)
$0 .......... Private Mortgage Insurance
$160 .......... Homeowners Association Fees
$5,981 .......... Monthly Cash Outlays

-$1023 .......... Tax Savings (% of Interest and Property Tax)
-$980 .......... Equity Hidden in Payment (Amortization)
$373 .......... Lost Income to Down Payment (net of taxes)
$144 .......... Maintenance and Replacement Reserves
$4,495 .......... Monthly Cost of Ownership

Cash Acquisition Demands
$9,950 .......... Furnishing and Move In @1%
$9,950 .......... Closing Costs @1%
$7,960 ............ Interest Points @1% of Loan
$199,000 .......... Down Payment
$226,860 .......... Total Cash Costs
$68,900 ............ Emergency Cash Reserves
$295,760 .......... Total Savings Needed

Property Details for 40 DESERT WILLOW Irvine, CA 92606
Beds: 5
Baths: 4
Sq. Ft.: 3168
Property Type: Residential, Single Family
Style: Two Level, Modern
View: City Lights
Year Built: 2006
Community: Columbus Grove
County: Orange
MLS#: P776945
Source: SoCalMLS
Status: Active

Short Sale!!!! This is a lovely home, well kept, great curb appeal, Big kitchen with island, large master suit with jacuzzi tub and seperate shower, One Bedroom and one Bathroom Downstairs, Hardwood like floors Downstairs, Carpet upstairs, Beautiful Back Yard for entertainment or Family gathering. Laundry room with sink, large community park and association pool. Original Oweners Put over $150,000 in upgrades!! Too much to mention, please bring your fussy Buyers they will absolutely fall in love with this home.

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