We just saw the FICO study a few days ago, here are excerpts from a report by the Federal Reserve Board, in an article written by Keith Jurow at the Business Insider:
Last May, a very significant analysis of strategic defaults was published by the Federal Reserve Board. Entitled “The Depth of Negative Equity and Mortgage Default Decisions,” it was extremely focused in scope. The authors examined 133,000 non-prime first lien purchase mortgages originated in 2006 for single-family properties in the four bubble states where prices collapsed the most — California, Florida, Nevada, and Arizona. All of the mortgages provided 100% financing with no down payment.
By September 2009, an astounding 80% of all these homeowners had defaulted. Half of these defaults occurred less than 18 months from the origination date. During that time, prices had dropped by roughly 20%. By September 2009 when the study’s observation period ended, median prices had fallen by roughly another 20%.
This study really zeroes in on the impact which negative equity has on the decision to walk away from the mortgage. Take a look at this first chart which shows strategic default percentages at different stages of being underwater.
Notice that the percentage of defaults which are strategic rises steadily as negative equity increases. For example, with FICO scores between 660 and 720, roughly 45% of defaults are strategic when the mortgage amount is 50% more than the value of the home. When the loan is 70% more than the house’s value, 60% of the defaults were strategic.
The implications of this FRB report are really grim. Keep in mind that 80% of the 133,000 no-down-payment loans examined had gone into default within three years. Clearly, homeowners with no skin in the game have little incentive to continue paying the loan when the property goes further and further underwater.
While the bulk of the zero-down-payment first liens originated in 2006 have already gone into default, there are millions of 80/20 piggy-back loans originated in 2004-2006 which have not.
We know from reports issued by LoanPerformance that roughly 33% of all the Alt A loans securitized in 2004-2006 were 80/20 no-down-payment deals. Also, more than 20% of all the subprime loans in these mortgage-backed security pools had no down payments.
Here is the most ominous statistic of them all. In my article on the looming home equity line of credit (HELOC) disaster posted here in early September (Home Equity Lines of Credit: The Next Looming Disaster?), I pointed out that there were roughly 13 million HELOCs outstanding. This HELOC madness was concentrated in California where more than 2.3 million were originated in 2005-2006 alone.
How many of these homes with HELOCs are underwater today? Roughly 98% of them, and maybe more. Equifax reported that in July 2009, the average HELOC balance nationwide for homeowners with prime first mortgages was nearly $125,000. Yet the studies which discuss how many homeowners are underwater have examined only first liens. It’s very difficult to get good data about second liens on a property.
So if you’ve read that roughly 25% of all homes with a mortgage are now underwater, forget that number. If you include all second liens, It could easily be 50%. This means that in many of those major metros that have experienced the worst price collapse, more than 50% of all mortgaged properties may be seriously underwater.
JtR Summary: These studies and charts show what we’ve suspected – that negative equity is the main reason why borrowers are doing strategic defaults.
We’ve been monitoring the NOD/NOT lists, but to stay ahead of potential defaults, you need to peruse the tax rolls and determine how many homeowners have negative equity in your target neighborhood. You can’t judge it by date purchased, because they could have refinanced in 2004-2007 – we seen many foreclosed who bought 20-30 years ago.
It needs to be a property-by-property search of neighboring streets around any home you are thinking of purchasing. It sounds like a lot of work, but it needs to be done – and realtors have access to the tax rolls. If there were 1-3 potential strategic-defaults within a block or two, you could probably survive them without a big hit to values. More than that might be pushing it.
I’m not sure studies and charts can really answer or explain the question as to why borrowers “strategic default”
All of these studies seem to be coming from academics and institutions associated with servicers and lenders such as Fico, FRB, etc. They look at factors such as negative equity, Fico scores, length of ownership, revolving balances.
None of these studies mention how the servicers treat borrowers and give them the brush off when they seek help. I think that is a big factor but you won’t see Fico mentioning that one to its customers when they try to sell them models that try to identify borrowers who are candidates for strategic default.
The other one you don’t see mentioned is the unintended consequence of strategic defaults caused by government policy itself.
Strategic defaults are also not so easy to always indentify. Our system encourages anyone wanting out of their mortgage to claim some sort of hardship. Its really not all that hard to rationalize or come up with a hardship story, especially when your lender won’t give you the time of day. Folks won’t usually admit that not paying their mortgage is a business decision instead of a need.
I notice the tax rolls at the county treasurer website show the tax amount but how do you know how much in loans they have out to determine if they are under water?
Kingside, I think you’ve got most of it. But, let’s consider a few other factors: if you bought the house with the intention to flip and make money in a couple years, then dumping it is purely a rational business decision calculation. I default, then I don’t have to pay, I move and move on with life and look for the next investment. If the equity is negative, then why would you bother trying to sell? Let the entity that gets all the money (lender) deal with the hassle.
As for servicers being a lot that makes the airline industry look like paragons of customer service, I think that feeds into the detachment. If there’s even a hint of sense that someone should attempt to pay, being treated like crap by the servicer (who isn’t the bank, but might as well be for these purposes), just hardens people to make the decision rationally and by doing math. And walking away might be the best way to do it.
IS there any statistic on how many people actually made traditional down payments of 20% or more on these underwater properties?
Not that I’m aware of
I would guess about 25% before they refinanced it out.