From Diana Olick at cnbc.com:
I have argued many times that just because a loan is underwater (value of loan is higher than value of home) it doesn’t necessarily mean that the borrower will stop making timely payments.
Yes, the incentive to abandon the home is there, but for most homeowners, their home is their community, their daily life, and not just an investment. Most probably think the value will come back over time, and unless they desperately need to move, they have no reason to stop paying.
Amherst analysts disagree with me. “Borrower equity status is the single most important predictor of success,” they claim. To explain their premise, they use two definitions of performing loans: A “successful” loan is one that is always performing, re-performing or voluntarily prepaid. A “clean success” takes out the re-performing loans. Here’s what they found:
For loans with equity, 88.9% were successful after 2 years, and 84.4% represented a clean success.
For loans with CLTV >120, only 53.6% of loans were successful and only 40.9% represented a clean success.
We talk a lot about the shadow inventory of foreclosed properties overhanging the market and weighing down inventories, but the inventory of potential new defaults is clearly high; that potential, even with steady economic recovery, exists and must be factored into the equation.
The latest home price reports are not good, and even though sales appear to be bottoming in some markets, prices always lag. Also, many of the sales are foreclosures (around 30 percent), so that knocks the price recovery premise on its head as well.
Here’s my mathematical interpretation:
Equity: 11% are failing.
120%+ CLTV: 46% are failing.
Note the last line in the last paragraph too.
Foreclosures and shadow inventory are the 800lb gorilla nobody wants to address.
Frankly, I don’t think you can necessarily predict behavior based purely on equity. It really comes down to borrower intent – did they buy a house to live in or were they speculating their way to household wealth via residential real estate.
Most of us spend a lot of money on things that we will never recoup – cars are a good example. Everyone who has ever bought a car knows perfectly well that by the time they pay it off it will be worth only a fraction of what they paid. Yet, still they go out and buy. They pay and pay and pay, then are left with an asset with little resale value.
But suddenly when it comes to a house, they think they are making an investment because we all *know* that housing only goes up.
If housing stopped going up – if you would never make a dime off your house over time – would you still buy? I would have.
Either you are buying a speculative investment or you are buying a place to live. The mentality determines whether you keep paying on house that is underwater or not. Yes, some people are between a rock and a hard place and default is their only way out.
“If housing stopped going up – if you would never make a dime off your house over time – would you still buy? I would have.”
The question becomes how much would you pay. You buy a car for it’s utility value and possibly as a status symbol. Certainly there are plenty of options when it comes to transportation/cars.
Obviously if housing wasn’t viewed as an investment then it’s value can change. The utility value is comparable to rent. If housing never went up then buying a home would cost less than renting it as there’s depreciation, maintenance, and profit to consider when comparing it to rent. Renting would typically be more expensive then buying because you wouldn’t need to perform maintenance and you’d be more mobile.
Of course fortunately for many people relying on home equity that’s not how the population currently views things. Most feel an emotional attachment to a home even if a lot of that emotion isn’t really towards the building but the location of that building and the stuff inside of it. Most feel that homes are still a good long term investment although long term is certainly becoming longer. People have been strongly conditioned to believe that all investments will eventually pay off in a long enough time frame.
The worst possible outcome would be for that belief to be called into question. We’d see a much different market for homes if that were to become the group think.
““If housing stopped going up – if you would never make a dime off your house over time – would you still buy? I would have.”
Welcome to the midwest. Where I come from house is a shelter nothing more nothing less. The store of value and inflation hedge in my area is farmland. Many folks live in 30k shacks but are worth millions.
it really isnt relevent because most americans dont live in a home for more than 7 years on average so all these underwater homes will be a real test if tese people need to move….
livin – I disagree that would be the worst possible outcome. Maybe for people who were buying for investment or expecting to rely on equity down the road, but for everyone who would like to buy in the future and enjoy the benefits that come from owning, it would be great.
The future is where we have to be looking. In order for prices to keep going up over time, wages have to keep going up over time. Right now, all signs are pointing to long term decreases in wages as the global labor market arbitrage takes over.
Tomorrow’s buyers are going to be making less money that today’s owners in most cases. Not only that, tomorrows buyers are graduating from college with six figures in student loan debt that cannot be discharged in bankruptcy and they are facing a labor market where wages are going down.
Housing prices cannot continue to rise at the entry and intermediate level (under $500k) under these conditions. In my opinion, this will create two distinct tiers of housing instead of the range we see now. The middle class is shrinking, which is going to affect the mid-range most significantly.
Jim,
A lot of boomers are near or entering the retirement age range. Many of them are in homes that are underwater. Many through no fault of their own.
We’ve got three trains headed toward the same intersection at the same time: 1)massive number of boomers moving into reduced income years, 2)massive number of homes/neighborhoods underwater 3)recession based economy with no clear signs of long (or short) term improvement
These three trains are crashing into each other right now. The only question is for how long?
Art- I tend to agree. It wouldn’t be the worst case scenario for everybody only those needing to rely on their home equity to retire or those looking at housing as a good investment. It would probably be better for the economy as a whole if shelter was just priced at it’s utility value. We have far too many many spending far too much of their income for a roof over their head. It doesn’t leave a lot of room for productive investment.
I also agree with the college debt problem. Effectively 20-30 years ago you could graduate college without excessive debt and your first major debt was to buy a home. Now you have a rather large portion of college graduates that are at least capable of finding a wage that would support home buying but are already in a pretty deep hole. I’ve always wondered who is going to buy all these houses when the boomer generation decides to downsize. Debt is effectively a claim on your future productivity and the banks have gotten their hooks into kids before they even had to chance to buy an asset in exchange for debt. An education has value but it’s a very illiquid asset.
Consultant,
Can you substanciate the statement that “many” boomers are underwater? Seems to me that the vast majority probably have owned their homes for quite some time and not encumbered by substancial debt…esp if they are planning to retire.
If boomers did not use the house as an ATM machine they should be ok, those that did are likely underwater. (75% of sub prime was re-fis for example) If you plan to live in a house for a long time then being underwater is not a major issue, but if you figure on moving every few years it is a big deal.
To me the biggest problem isn’t being underwater, it’s that being underwater prevents you from refinancing to get a better rate or to go from a variable to a fixed rate loan. To me if that issue could be addressed and underwater loans could be refinanced, that would go a long way to fixing this housing crisis. Most of the people I’ve known who have lost their homes are because of the inability to refinance, not job loss. And if someone refi’s for the current balance (without being able to take extra money out), the bank with the mortgage doesn’t take on more risk (in fact they have less risk) so it would be a win-win. I believe the issue is because of reselling the mortgages in the secondary market, but if it is at the same bank for the same $ amount, I think there needs to be some way to get around that issue and be able to override underwriting standards and get the refi done.
Kathy, it matters a lot what kind of loan product the borrower has. Rate resets are not a problem right now. Recasts are more of an issue.
Calculated Risk had a very informative post up a few days ago on the topic.
http://www.calculatedriskblog.com/2011/01/what-about-those-option-arms.html
Obviously the housing bubble caused people to act irrationally but there are 2 critical things I don’t really get.
1) Why would you ever buy a house under terms that require some kind of refinancing. If you require some kind of teaser rate to afford the property you probably shouldn’t be buying it.
2) Why do so many of these sob stories (people losing houses) involve people in their 50’s and 60’s. If you’re nearing retirement how do you ever expect to pay the loan off. Why would you take on so much debt at the age. Of course for a lot of these people, they probably figured buying this house would be their retirement salvation.
One of the things I noticed during the housing boom was that it wasn’t a bunch of young right out of college first time buyers, some of them did get involved in it. It was quite a few older first time buyers.
Art Eclectic: Thank you for that article…that was fascinating! The graph so clearly showed that we are in deep bandini until 3Q 2012, then the bad loans just go away. Hopefully that means less supply, which will make prices start to go up. Thank you!