For those who don’t read Dr. Housing Bubble regularly, click here for his most recent examples of how neg-am mortgages are being modified.
One borrower was given interest-only payments for 10 years – with a rate of 3.75% for the first five years! Another borrower got modified onto a 40-year program, which saves about $260 per month on a $500,000 mortgage at 5.5%.
His point was that these loan modders are getting long-term fixed payments that are as much as 20% to 30% below market rents. But it will also frustrate those of us that are hoping for more well-priced inventory coming to market, because these mods have a better chance of sticking.
These borrowers probably think they’ve scored. But while they’ve managed to keep their heads above water, the ocean beneath them just got deeper.
Extend and pretend. How sad. I do agree that until the govt. realizes how these types of market manipulations creates extreme mis-allocation of capital, we will have tepid economic growth at best.
I guess it’s great for those of us either with secure jobs, mostly paid off homes, or those who bought a house they never could afford (no deserve) but are crying a river of how they will loose their house.
Bottom line to those who like this type of extend and pretend — look at Greece because that will be our fate within 10 to 15 years if this does not stop. Do you really want China in 15 years telling us how much we can pay employees, how much govt. spending we can have etc? If not I suggest writing your senators constantly and making sure all encumbants who support extend and pretend are removed from office.
Pardon the financially unsophisticated question, but I don’t understand who the “end-investor” of the new, modified loan is? My understanding is that whoever is putting up the money behind the mortgage is now going to get very little, if any, return on investment. To me, it makes no sense to put your money in this type of scheme when you can put your money in treasuries at a higher yield.
I suspect the answer maybe for me to look in the mirror to see the “investor”, but I haven’t read anywhere stating that any of the government agencies are approving these types of loans.
The only other answer I see is that banks are doing this on their own because they are too scared to write down the loans. Instead, they are putting all their eggs on the hyperinflation bet to bail them out.
To me, it makes no sense to put your money in this type of scheme when you can put your money in treasuries at a higher yield.
10 year treasuries are sitting at 3% and 30 years at 4%. Those quoted rates are higher than treasuries, but whether or not they are high enough to be worth it is more of a judgment call instead of a fact.
Jordan and alles_klar,
Forget that. They are probably putting them in FHA streamlines (which allow negative equity). You can get a 5 year arm right now for mid 3’s in FHA.
What’s that? You want to know who is underwriting 3 percent mortgages. Well, well, well. Now we can chase that rabbit down the hole. Who do you think is underwriting mortgages and accepting 3% returns for the next 5 years?
BTW, Jordan is right. 3% is probably not too bad if you want “safe” investments. That’s what you get because everyone else is in cash now too. You have to pay a price to do what the herd is doing.
Chuck
A bankrupt scheme by a bankrupt banking system backed by a bankrupt government.
Makes you sick, doesn’t it.
Regarding the 3% comments, from what I understand, a 3.5% interest payment does not mean that the “investor” is going to get a 3.5% rate of return. Everyone else in the chain is going to get their cut first. For example, the mortgage servicer is going to get a few points and everyone else down the line too. So the entity that put up the cash would be lucky to get around 2.5%, if that.
If true, I’d certainly elect to stash my cash in treasuries in this instance. But I’m sure I’m missing something.
These aren’t new MBS for investors though, just a view of the collateral damage from the downturn.
Some of the MBS investors have the servicers foreclose, and lose 25% to 50% of capital after a year or two of no payments/ROI. Others get caught up in these loan mods and pray for a brighter future.
The 40 year loan mod is a joke. Talk about kicking the can. Unpaid principal Balance 472k. New Maturity date 06/01/46. It’s like you’re just renting from the bank. Home ownership? HA! I guess the hope really is for hyper inflation.
As I was just writing a post about how these people are stuck and cant sell, I realized – oh yes they can!
If I got a loan mod like that, I’d rent the place out and pocket the cash!
In general, add in property taxes, insurance, and maintenence, and they are not really paying 20-30% below market rents.
This type of mod on the neg amms have been around for a while now and I don’t think it is really news. I think on the blog about a year ago we were talking about Wells Fargo doing this kind of deal with the Wachovia/World savings pick a pays, except that Wells Fargo was not capitalizing past due interest, and actually knocking off as “principal reduction” some of the accrued neg am interest and delinquent payments.
Getting transferred to a 40 year mortgage is a very bad thing, but fortunately for banks most people aren’t good at math. Instead of making 360 payments, you’ll be making 480 and the interest will compound more. That’s *why* your payments are slightly lower – you end up paying a ton more.
The interest only deal is basically a stock option on your house. After 5 or 10 years, you check again to see if you can actually afford real payments on the house. If not, what are you going to do, foreclose then? By definition, the house is too expensive regardless of how much a richer person would pay to rent it. How is renting for 5-10 years and then choosing to buy versus foreclose a good idea? Maybe if you knew you were going to die before then, sure.
At risk of beating a dead horse… I’d love to hear any comments poking holes in my thoughts below. I simply fail to see the reasoning why an investor would approve these modifications.
It seems that an MBS investor would only choose an extended low interest modification if the investor believes it will recover more money by extending and pretending than it would if it foreclosed. Keep in mind that money recovered from the foreclosure could then be put in a higher yielding investment.
Thus, a “rational” investor would be betting on the value of the house to outpace the yield from investing money recovered from the foreclosure.
At the risk of oversimplifying things, I see only two plausible scenarios for home prices to recover quickly (on a macro level). First, home prices are now depressed and will shoot up to get to a more normal levle. Or, second, incomes significantly increase due to high inflation and/or economy roaring back.
I think the first scenario is unlikely because, as seems to be the overall consensus, we were in one of the largest housing bubbles of all time.
The second scenario would be more likely to happen, but inflation would eat away the value of the MBS investment. That is, I would think one could invest the money recovered from the foreclosure in other investment vehicles that get a better return in such a scenario.
Alles – most of the MBS people have already sold their securities at a loss over the past 2 years.
The new ownes are in for some % of par and thus their effective interest rate is much higher than the 3.5% quoted.
Ex: if I bought at 50 cents from a distressed seller then my yield (excluding servicing) would be 7%.
but wait…now I borrow money cheaply (say 0%-3%) at a very high % of value and now my yield soars above 10%.
I’ll take 10% for 40 years that I can then sell back into the fixed income market at 90 cents and make a capital gain of 40cents plus a few years of 10%+ interest secured by an ultimately rising value of the underlying security (or so we hope).
Anyone want in on that deal???
Actually a 40 year mortgage comes aweful close to a long term lease, with the owner paying the expenses usually paid by the landlord. Once you go 40 you might as well go 99 years. At that point you never have any equity, and it is truly a lease. (Note that lot of land in the UK is handled this way, although the structure may be owned). In Ca that might well work, in that so much of the value is in the land, and it does not need to be maintained. So put out a 99 year lease on the land, and build your house.
I’d take a 40yr fixed at 5.5% in a heart beat and keep my current mortgage payment at 6.3%. Who says some of these weren’t strategic?
It’s still a tsunami – it’s just that it’s a tsunami of loan mods….
From foreclosureradar.com:
“The number of foreclosure sales that were cancelled hit an all time record in June, but the increase was primarily driven by just one lender, JP Morgan Chase, and it’s acquisitions including Washington Mutual.
Although the number of properties purchased by 3rd parties at auction dropped significantly, they purchased nearly the same percentage of the total properties sold, and at a better discount-to-market value then we’ve seen in months.”
“The real estate gods have canceled Armageddon!” said Jim Klinge, a Carlsbad real estate agent. “At least for now.”
Bottom line to those who like this type of extend and pretend — look at Greece because that will be our fate within 1 to 5 years if this does not stop.
FIFY.
Looks like a win for the home owner for me.
I know it’s a win for the bank.
Think about it. The choice is for the homeowner to lose the home. The bank take a beating *or*
they borrow free money from the government, let the ‘owners’ rent it for $1600/month for five years, then rent it for another 5 years at $2100, then move into a 30 year loan in 2020 at 5% interest.
Stunning win for the homeowner.
They get to keep it and basically get below market rent and if homes increase in 10 years, they make out.
You cannot simply keep your eye solely on the real estate. All of these moves are to save the banks. Despite getting hundreds of milions at 0% the whole system is in danger of collapsing if real estate prices do. Many of us want to see us take the medicine now. Washington and New York see things differently.
It’s sad that on 40 year loan mods, the average person doesn’t care about the total they pay out or the compounding of that interest over time.
All they want to know is “What be my monthly?”
When it comes to buying a car, how many times does the car salesman just ask, what do you want your monthly payment to be.
When it comes to buying a house, a lot of the decision comes from, “What be my monthly?”
So, I can see on 40 year loans, the average person is just concerned about “What be my monthly?”
You mean at 3.5% you can actually lower my monthly payment, even though you’ve extended my loan another 10 years! Yippieee!!! I can now go buy a new car with the difference!
Many of us want to see us take the medicine now. swm | July 14th, 2010 at 9:10 pm
I don’t. Taking the medicine now would mean a 30% unemployment rate and the Second Great Depression. Nobody wants that.
History does not speak well of using fear to justify interference with markets and avoidance of true price discovery.
#18 above + this:
J.P. Morgan Chase posted a 76% rise in second-quarter net profit, topping analysts’ estimates. It improved net income in every line of business except investment banking.
First, let me state that the Option ARM is a horrible, horrible thing that might be something worth banning, or heavily regulating.
As for whether these mods are good or bad, I guess I don’t see the harm here. Scenario 1 is no mod, and the house goes into foreclosure. Distressed Asset investors can profit, but the home owner loses, the neighborhood loses and the bank loses because they now have a realized loss on the house when they resell it – in the usual post-REO craptastic condition- at less than the note.
Scenario 2, there’s a loan mod, the buyer keeps the house, the bank gets something close to or at the original purchase price, the neighborhood doesn’t have REO-blight and everyone is generally better off. Only investors are harmed and not really because there are other investment opportunities. (I hear all the conservatives like gold…) Now, sure, this does “kick the can” a bit, but I see this as helping prevent further blight. To me this is pareto optimal outcome.
Alles Klar,
You might want to go read up on HAMP. Fannie and Freddie and FDIC owned loans are getting exactly these kinds of mods. Thank President Obama, Timmy Geithner and Barney Frank for giving away your money (assuming you pay taxes which pay the Chinese for their treasuries yield) in pursuit of vote getting populism.
More frighteningly, on the private sector side, the “investor” doesn’t really exist anymore. The loan is in a pool (technically a trust), and the bondholders merely stand in line for the stream of payments, which stream gets reduced to a trickle by mods, so only the people with bonds at the front of the line keep getting paid. But they don’t actually have a say in whether the mods are granted or denied, or what kind of mod is given! Under the PSA (pooling and servicing agreemen) that created the trust and the bonds, there are supposed to be parameters limiting or even barring modification, BUT SERVICERS ARE ROUTINELY IGNORING SUCH CONTRACTUAL RESTRICTIONS. Why? Because apparently TARP and HAMP and the Obama Stimulus bill immunize servicers from being sued for giving mods that breach the terms of the contract. (I know, it’s tough to believe this Congress and President wouldn’t respect the sanctity of contract.)
As if that weren’t enough, I have personally communicated with the megabanks who are technically the Trustees for these pools of loans, and they say they do not have any involvement in decisions re foreclosing or modifying or short sales, etc. They say it’s all up to the servicer. And guess who gets paid first out of every payment received? You got it – THE SERVICER! Guess who gets to rack up fees during the default and pre-foreclosure sale process, which fees get paid out of any resumed payment stream (i.e. following mod or reinstatement)? Right again – THE SERVICER!
Now, I am sure that some PSAs actually create a true investor with a true trustee looking out for their interests, but I haven’t seen one yet. And even if that were the case, then there is the accounting problem that foreclosing on an underwater house equals an immediate loss, while modifying that same underwater loan actually slightly INCREASES the booked value at the new principal loan amount.
I think that in 20 years, somebody at the Fed will finally publish a paper concluding that RMBS and CDO, combinded with perverse accounting standard accomodations, eliminated all market incentives to manage the underlying real estate assets properly and replaced them with incentives to extend and pretend.
RB Resident,
Allow me to disagree. Foreclosure and sale would benefit the economy and the nation far more than the current approach. How?
On a macro level it forces the rapid repricing of mispriced assets, which is fundamentally the problem the world econmony has right now. Not just houses, but all asset classes have been bubbled in value over the 2003-2008 period. That has to be unwound before real economic growth can return.
On a national level, every modified loan homeowner gets locked into that home for the next decade or two. So you eliminate huge numbers of future homebuyers. At the same time, by artificially constraining supply, you keep prices for discretionary (i.e. nondsitressed) sellers artificially high, which prices out a huge segment of potentially buyers. You thus inhibit new household formation, which in turn significantly limits residential investment, both in terms of remdodeling and new home construction.
Imagine if, instead, everything got foreclosed and sold. This would do two things. First, it would incentivize anyone who is defaulting in hopes of a mod to stop and reinstate the loan. This would reduce the current default rates that are partly driven by the moral hazard incentives created by forebearing from immediate foreclosure and promoting loan mods. Second, it would add significant inventory and force real estae pricing, especially in the market above $800k, to come down to true market clearing prices, probably another 10-15% depending on location, at which point you would see HUGE numbers of buyers emerge, many of them forming new households, which then drives furniture sales, remodeling, etc. And the people being forced out of those homes would go rent something they can actually afford and start rebuildign their finances so that in 5-10 years, they are potential buyers, instead of permanent prisoners in an underwater house. That would add several points to GDP growth within 6 months and would bring back many RE and contstruction related jobs that have disappeared since 2007.
There would not be blight in nice areas, only in the low priced areas where foreclosures are bought by investors who rent them instead of flipping them. And that has already played out (e.g. Rancho Cucamonga, Barstow, etc.).
I agree with Sean. Financial crisis is not uncommon in history. But normally market can work it out average in 6 month. You can argue this time is different.
There is certainly a wealth re-distribution process during financial crisis. Without gov intervention, it will be from debtors(risk overtakers) to savers. But currently, it is the other way — risk takers got profit on the asset price rising and bailed out on the asset price descending.
Here’s the real problem in RRE: they aren’t really “assets” until they are for sale. A person bought the place to live. Assuming they didn’t hit the housing ATM, then the current value of the house (whatever it is) isn’t really of consequence until the person tries to sell or re-fi. With Option ARMs and the need to re-fi, then yes values become relevant and that’s where the problem starts. The new reset payment isn’t affordable, and they can’t get a refi because they are hundreds of thousands of dollars under water. They don’t want to sell, they want to stay. They want to make the payments, but can’t afford. By forcing foreclosure you are forcing a repricing of an asset that the holder really didn’t want to sell in the first place.
And, personally, I think the whole “moral hazzard” argument is a complete red herring. Encouraging foreclosures so that investors and flippers can swoop in isn’t really what I consider morally superior. Not morally inferior mind you, it just isn’t an issue of morals, just money.
A mortgaged house is two separate assets. The loan is one, the collateral (the house) is another. Nonperforming loans are overvalued assets unless the actual sale value of the collateral exceeds the net balance due AND the lender liquidates the collateral.
As you point out, so long as Joe Homeowner can pay and will pay to cover the nut on his loan(s), and isn’t trying to sell in order to move elsewhere, the liquid value of the collateral is not relevant. But at this historical moment, 13% of loans are nonperforming and some very high percentage of those nonperforming loans are undersecured. So the lender should liquidate, resulting in a loss on the loan and a revaluing at market prices of the collateral. The alternative is Japan 1989-2005. And it’s not just RRE. It’s CRE and almost all asset classes that got run up over the past 7-10 years.
Excellent posts, Sean.
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The new reset payment isn’t affordable, and they can’t get a refi because they are hundreds of thousands of dollars under water. They don’t want to sell, they want to stay. They want to make the payments, but can’t afford. By forcing foreclosure you are forcing a repricing of an asset that the holder really didn’t want to sell in the first place.
And, personally, I think the whole “moral hazzard” argument is a complete red herring. Encouraging foreclosures so that investors and flippers can swoop in isn’t really what I consider morally superior. Not morally inferior mind you, it just isn’t an issue of morals, just money.
Former RB Resident | July 15th, 2010 at 1:21 pm
The bolded portion outlines the problem. I might want to buy a Ferrari or a Beverly Hills mansion, but I am NOT entitled to it just because I want one.
These houses should be foreclosed on and sold quickly — preferably to new owners who were responsible and didn’t get “toxic” loans or pile on their debt. They should be sold to people who CAN afford them at the new, affordable price, using very conservative loans with high down payments, or no loans at all. That would prevent any “blight” from happening, as it’s usually the deadbeats who cause the blight, not the foreclosure itself.