NY Times Article: Enjoying the Fruits of Foreclosure

[brewer12345]

Yeah, that is not a choice anyone would like to make. If in that position I'd be looking at every legal means available. I'd also be cutting my expenses to the bone, selling off toys, and shopping at foodbanks if necessary. I do know the feeling, having dealt with an unexpected 50% income reduction about two years ago.

That is why some people (I suspect both of us) live very conservatively. That way when life does throw a curve ball we can handle it without having to bail on our commitments. Which is why I don't have much sympathy for these folks and think what they are doing is wrong. The bank didn't make them take the loan, didn't make them buy expensive toys, nor did it make them invest poorly, if at all. Yet they are making the bank (and the rest of us) pay for their lack of financial understanding.

I guess you see the world through a different lens than I do. As a credit analyst, I have seen lots (and lots) of situations where a loan goes bad. In just about every situation, whether a corporate loan, commercial real estate, consumer, or whatever, the debtor just about always acts in their economic interest. You will deny it, but I have no doubt that you would do the same, as would I or anyone else.

 

[Keim]

Brewer_I edited my prior comment quite heavily to try clarifying my position. You may wish to re-read. Sorry about that!

I will add: I thought I pretty much conceded your point in my first paragraph of my previous note. I WOULD look at every legal means available. I would also slash EVERY expense I could to the bone, and sell my expensive toys. For instance: The boat they mention would be sold. Cellphone? Cable tv? Car with a payment? all would be done away with. In short I would do everything in my power not to be in that position, and to live as cheaply as possible if I was. The people in this article don't seem to be doing that.

Yes, if at all possible, I would continue to pay on my mortgage if I was underwater on it.

 

[Hamlet]

I'd love to see some actual statistics on this "problem".

Are there really a large number of people strategically defaulting on their mortgages?

Or is this a media manufactured "problem"?

I just don't see a whole lot of people benefiting from allowing their homes to go into foreclosure, unless they are already in a pretty bad financial spot.

In order for this to be a good strategy, the following things have to be true--

1. You need to be significantly underwater in a mortgage. This one is easy, as there is no shortage of people in the boom states that are way underwater.

2. You are willing to mostly do without decent credit options for at least several years

3. You have to be willing to give up owning a home and start renting again. I think this is going be a big deal a large number of people. Even if if was financially advantagous, I don't want to go back to being a renter. Just the hassle of moving alone would make me keep paying my mortgage.

4. You have to be able to actually pay your mortgage. If you are in severe financial distress, you aren't "strategically" defaulting. You're just a normal foreclosure.

5. You have to be morally ok with walking away. In general, I think most people are going to try to pay their obligations unless they create real hardship.

6. You have to actually understand that it would be beneficial to walk away. Most people who buy new cars are severely underwater on them in a year or two, but they make the payments if they can. I think most people will do the same with their homes.

Until someone actually comes up with real stats on this "problem", I'm going to assume its mostly bull.

Another "proof by anecdote" article. Are there any statistics regarding the number of people who could afford their mortgages (e.g. have the same job at the same pay they had when they took out the mortgage, haven't had disastrous medical expenses, etc.) but just decided not to pay because they are underwater?

The article jumps from a story about someone still owns an airboat to gross numbers for all late payors with just a few words "no firm figures" to indicate that they really aren't connected.

My daughter bought near the peak, lost the job that was supposed to pay the mortgage, had a personal tradgedy, saw the market value of the house drop by 30%, and is now mailing her 401k money to some investors somewhere. If she asked, I'd suggest she tell the lender she'd like to do a short sale then stop paying the mortgage.

 

[Keim]

To be clear (Thanks Hamlet!):
The people I have a problem with are those that fall under number 4.

I'd love to see some actual statistics on this "problem".

Are there really a large number of people strategically defaulting on their mortgages?

Or is this a media manufactured "problem"?

I just don't see a whole lot of people benefiting from allowing their homes to go into foreclosure, unless they are already in a pretty bad financial spot.

In order for this to be a good strategy, the following things have to be true--

1. You need to be significantly underwater in a mortgage. This one is easy, as there is no shortage of people in the boom states that are way underwater.

2. You are willing to mostly do without decent credit options for at least several years

3. You have to be willing to give up owning a home and start renting again. I think this is going be a big deal a large number of people. Even if if was financially advantagous, I don't want to go back to being a renter. Just the hassle of moving alone would make me keep paying my mortgage.

4. You have to be able to actually pay your mortgage. If you are in severe financial distress, you aren't "strategically" defaulting. You're just a normal foreclosure.

5. You have to be morally ok with walking away. In general, I think most people are going to try to pay their obligations unless they create real hardship.

6. You have to actually understand that it would be beneficial to walk away. Most people who buy new cars are severely underwater on them in a year or two, but they make the payments if they can. I think most people will do the same with their homes.

Until someone actually comes up with real stats on this "problem", I'm going to assume its mostly bull.

 

[Bestwifeever]

....In order for this to be a good strategy, the following things have to be true--
...

2. You are willing to mostly do without decent credit options for at least several years

3. You have to be willing to give up owning a home and start renting again. I think this is going be a big deal a large number of people. Even if if was financially advantagous, I don't want to go back to being a renter. Just the hassle of moving alone would make me keep paying my mortgage.

....

Five or so years ago a good friend was divorced with credit rating ruined by the spouse's behavior (both were on all the credit cards, car loans, mortgage, etc., so both credit rating were ruined). Housing market was still strong though and they received a nice chunk of change from the sale of the house during the divorce proceedings.

Good thing, too, because my friend was not able to rent an apartment due to the abyssmal credit rating, which all landlords were checking. Prepaying an entire year's rent was the only option.

So homeowners who default and have poor credit (#2) may not even find it easy to become renters (#3).

Foreclosures also affect all of us who live in a neighborhood with foreclosures and short sales as our resale potential plumments accordingly--a buyer can buy a distressed property and even pour some $$ in ti to fix it up for much less than the traditional sale.

 

[brewer12345]

Brewer_I edited my prior comment quite heavily to try clarifying my position. You may wish to re-read. Sorry about that!

I will add: I thought I pretty much conceded your point in my first paragraph of my previous note. I WOULD look at every legal means available. I would also slash EVERY expense I could to the bone, and sell my expensive toys. For instance: The boat they mention would be sold. Cellphone? Cable tv? Car with a payment? all would be done away with. In short I would do everything in my power not to be in that position, and to live as cheaply as possible if I was. The people in this article don't seem to be doing that.

Yes, if at all possible, I would continue to pay on my mortgage if I was underwater on it.

It would depend for a lot of people, including me. If I were modestly underwater but not in dnger of payment default, fine, I keep making the payments. If I were underwater by a million bucks, sure I would walk away from he house if it were non-recourse.

 

[clifp]

Morality aside, that's the bottom line (so to speak). Businesses write off outstanding customer invoices all the time. It's a cost of doing business. Do the customers feel like they must pay such invoices? No, in many cases they decide that making payroll, financing their latest shipment, etc... are more important than paying off an invoice from a particular vendor. True, they're burning a bridge with that vendor, but there are plenty more vendors out there willing to sell to them (perhaps on tighter credit terms).

I'm all for paying one's debts. But if businesses can "get away with" not paying off their debts (or reorganizing in bankruptcy and eliminating the value of their common stock), why can't individuals do the same?

EDIT: One more thought. Why are we blaming the individuals here? If banks were so hell bent on being paid on outstanding mortgages, why aren't they going after the deadbeats? The answer is "for a variety of reasons," but only one really matters - they don't want to do so.

My opinion on this has evolved over the crisis. I used to think that it was immoral, but now I think it is strictly a business decision. Much more importantly if we and society view this as moral issue it really won't get solved.

The desired outcome for everybody is to reduce the number of people walking away for their mortgage. It is clear a few years into the crisis that nobody has figured out a good way of doing this. The government has focused a lot on providing carrots to encourage folks o keep paying in the form of loan modifications. I have some issue regarding moral hazard but primarily I dislike it cause it just isn't working; very few loans are being modified and those that are modified often still result in people defaulting. Congress has also eliminated the rule that use to treat debt forgiveness as income and made people pay tax on it.

The unintended consequence is that people like these now think that they have a right to have their loan modified and when the process goes to slow for their liking the often just stop paying. So we have made it very attractive for people to walk away.

At the same time we increased the carrot for walking away we've decreased the stick. I'd like to see this reversed and I think the banks have a primary role in doing so and should be supported by the media and the public at large. The social stigma for defaulting on debt is certainly vanishing among a large segment of the population, and 1/2 expect that banks in the future won't put as much weight on your credit rate in the future as the in the past.

It is true that primary reasons banks aren't going after deadbeat because they don't want to. I am not sure of why they don't but I am guessing it is partly because of the bad publicity, partly because the legal system is so backlogged, and primarily cause it isn't cost effective.



We prosecute shoplifters
For years I wondered about this sign that I see in many but by no means all stores. It seem to me like duh of course you prosecute shoplifters. I eventually figured that it was expensive for a store prosecute a shoplifter and often resulted in bad PR. "Scrooge-like store sends poor single mom to prison for stealing milk for her baby" It is far easier for a store who catches somebody shoplifting a dress or a couple DVD. To give the shoplifter a lecture, threaten to throw the book at them if they do it again a release them with a warning. However, if every store gave a free pass to first time shoplifter, the result for society is that every shoplifter would keep stealing until they got caught then switch to a different store. So fortunately stores sacrifice a bit of short term profits to punish shoplifter. We still have a problem with shoplifting but I don't think anyone can make the case that it is economically sensible to steal items from a store. I contend that fear of punishment keeps a lot of people from stealing more than the a desire to to the right/moral thing.

Unfortunately, this is not at all true when it comes to paying your mortgage. Economically, it often makes sense to walk away, and until society increase the consequences I don't see it changing.

 

[Tadpole]

In my area, many houses were sold way over their real value during this madness. I suspect many homeowners are upside down. Yet, there are very few foreclosures; almost none.

Two factors come into play in my mind. One, the average education is far above the average in most areas which makes me think fewer people bought into funny balloon loans. Second, job stability in the immediate area is far above normal so people can afford the mortgage on their homes even if the homes are underwater.

The area? The major employer is Aberdeen Proving Ground which has a large number of government and contractor scientists and engineers and is a BRAC winner. The BRAC winner part means that housing fell but not as far as in other locations.

I have to agree with Brewer here. It's a business decision even for individuals. If the company that laid you off can get out from under and your neighbors think that's business; why not you? Morals/ethics are a two way street. If the owners do something and they are presumably "leaders", why is anyone surprised that the workers start questioning why they are held to higher societal standards? And yes, no debtor prisons; such stupid should never enter society again especially as long as sharks roam the seas and the lands with legal protection.

I think the playing field should be a even as possible. The stupid certainly was. If even Buffett says not to be tough on Lehman's since "no one saw", then stupid got together with stupid to cause these problems. I say this because anyone with a brain could see that the value of a house was limited by the price that the buyers could afford with predictable mortgages and at normal mortgage rates, not extremely low rates or balloon rates. (That same person might need to sell the house after rates went up to normal.)

 

[stephenandrew]

So what are the consequences of walking away from a house/mortgage? I gather that in some states, the lender has the right to go after other assets of the borrower to make them whole. I assume your credit is ruined--but what does this mean? Can you ever get a credit card again? Qualify for a mortgage?

 

[Walt34]

And here I am, toting PBJ sandwiches to work every day, sharing 1 car with husband, throwing extra money at the mortgage so we can be free of it when I retire. Some days, we feel like chumps.

Amethyst

You're not the only one. DW's nephew and wife are upside down on their townhouse and plan to "wait it out" until housing prices either go up or they've paid off enough principal to set their sights on a larger single-family home for their two kids. But they both have jobs so it is possible for them to do that.

Despite the newspaper stories, I suspect that's what most people are doing.

 

[brewer12345]

So what are the consequences of walking away from a house/mortgage? I gather that in some states, the lender has the right to go after other assets of the borrower to make them whole. I assume your credit is ruined--but what does this mean? Can you ever get a credit card again? Qualify for a mortgage?

I think if you search the internets, you will find detailed explanations. In short, you lose the house (duh), your credit is wrecked for 3 to 5 years, Fannie and Freddie will not buy a mortgage from you for a few years (and they make he market these days), and depending on the state and circumstances the lender may be able to sue you for any deficiency between what they are owed and what they get net from selling the house. The last one depends on the state and may be amelliorated by doing a short sale, as in most cases a condition of the occupant of the house vacating gracefully is the lender agreeing not to sue for deiciency. In addition, Fannie and Freddie have now restarted "deed for lease" which was originally started in the Depression. Basically under certain circumstances they agree to take the upside down house and give the occupant a legal lease to stay there as a tenant as long as they pay a market rent. The somewhat hazy notion is that in a few years when the former owners have pulled themselves together financially they may be the logical buyers of the house from Fannie/Freddie.

Don't we live in a sordid little world? This sort of thing is why I think "workout" credit professionals (aka knee-breakers with MBAs) have an interesting but difficult job and earn every cent of their pay.

 

[chinaco]

Investors and tax payers lost on this debacle.

Laws from state to state are different. But even with that, people who signed a loan contract are on the hook for that mortgage, legal and other expenses.

The wheels of the legal process may run painfully slow, but eventually it will catch up with them. Want to know why? Because money is involved. Whether it is a bank, a group of investors, a collection agency... someone is going to try to collect the debt!

Those people can say whatever they want... be defiant, try to rationalize their actions. But in the end, most will not walk away unscathed. It is likely that many people will negotiate some sort of settlement. Even if they file bankruptcy... the courts will probably not wipe the slate clean unless they have no other assets or very low income.

Oh... and any debt forgiven is likely to be treated as taxable income... The IRS is waiting. While they will negotiate... in times of needing tax revenue, you can bet they will be much less willing to let it go!

 

[Dog]

It is sad to see the loss of personal responsibility in our society. A slippery slope in my opinion.

It's possible that living in the home and not paying the mortgage may be more common than we think - some may not want to admit to it.

Ultimately, why worry about a credit rating? If enough are impacted, then congress will pass legislation to reset everyone's credit rating - level the playing field.

 

[73ss454]

I'm sure there are people in trouble and struggling with their debts.

I know 3 people who are taking advantage of the situation also.

1> This guy is making big money and working off the books. He is up to date with his debts and has great credit. He tried to modify his first mortgage with no luck. He ran up his second mortgage to about 200K and wrote some BS letter to the lender and made a deal to pay 45K for a settlement. This happened just recently and he's laughing his a$$ off.

2> This guy had no mortgage and took a home equity line of credit and ran it up over 200K and now his house is worth about 130K. He also wrote some sob story to the bank and is negotiating with them for 115K cash settlement. Also laughing his A$$ off at the bank.

3> This guy hasn't made a mortgage payment in 2 years. He's sitting in his house waiting for his lawyer to get him a deal. Also laughing his a$$ off that they can't get him out of his house.

I don't find any of this too funny.

 

[stephenandrew]

Oh... and any debt forgiven is likely to be treated as taxable income... The IRS is waiting. While they will negotiate... in times of needing tax revenue, you can bet they will be much less willing to let it go!

It would seem to me that this is a time bomb waiting to explode for those who don't keep up with their mortgages. From the NY Times article, it sounds as though some folks may be walking away from tens if not hundreds of thousands of dollars in debt. I am assuming this may amount to thousands if not tens of thousands of dollars in taxes due to the IRS. What happens then? I am assuming the IRS is not very forgiving.

 

[brewer12345]

It would seem to me that this is a time bomb waiting to explode for those who don't keep up with their mortgages. From the NY Times article, it sounds as though some folks may be walking away from tens if not hundreds of thousands of dollars in debt. I am assuming this may amount to thousands if not tens of thousands of dollars in taxes due to the IRS. What happens then? I am assuming the IRS is not very forgiving.

My recollection is that Congress changed the tax laws last year so a deficiency on default on your mortgaged primary residence is not considered taxable income any more.

 

[Onward]

a deficiency on default on your mortgaged primary residence is not considered taxable income

That's right, with some restrictions:

Home Foreclosure and Debt Cancellation

State tax is another matter. States may or may not follow the federal rules.

 

[73ss454]

Glad to see the Feds are sweetening the pot for people who aren't paying. I'm sure the 3 people I mentioned in an earlier post will be laughing a lot harder.

 

[brewer12345]

Glad to see the Feds are sweetening the pot for people who aren't paying. I'm sure the 3 people I mentioned in an earlier post will be laughing a lot harder.

If I were them I would be worried about being brought up on fraud charges. But then, I am a planner and worrier and people doing this stuff most assuredly are not.

 

[73ss454]

If I were them I would be worried about being brought up on fraud charges. But then, I am a planner and worrier and people doing this stuff most assuredly are not.

I'm with you, I've always paid the freight and plan on keeping it that way.

Once I was screwed when buying something on Ebay. Of course Ebay didn't do a thing about it so I went to the US Postal Office to report the fraud. They pretty much just laughed and told me that they don't have the funds to do anything about people doing 100K frauds no less a few hundred.

So chances are these people will just keep laughing all the way to the bank.

 

[stephenandrew]

My recollection is that Congress changed the tax laws last year so a deficiency on default on your mortgaged primary residence is not considered taxable income any more.

I am clearly a fool for paying my bills. You know the regular debate that goes on here about prepaying your mortgage or carrying a mortgage for its full term? I think we need to change the options---is it better to pay your mortgage (in any shape manner or form) or not pay it? I am leaning towards the later.

 

[brewer12345]

I am clearly a fool for paying my bills. You know the regular debate that goes on here about prepaying your mortgage or carrying a mortgage for its full term? I think we need to change the options---is it better to pay your mortgage (in any shape manner or form) or not pay it? I am leaning towards the later.

If you are well along the way to FIRE and have lots of assets, I think not simply because you would be an easy target ("sue the deep pocket"). For those who don't have a pot to piss in, its a different story. Personally, I like having lots of assets and lots of options, so paying the mortgage doesn't bother me so much.

 

[clifp]

I'd love to see some actual statistics on this "problem".

Are there really a large number of people strategically defaulting on their mortgages?

Or is this a media manufactured "problem"?

...

Until someone actually comes up with real stats on this "problem", I'm going to assume its mostly bull.

You've want data. I thanks, to Google, have data.

Morgan Stanley recently published a good study called Understanding Strategic Defaults. In this study they looked at 6.5 million recent mortgages of which 2.5 million had defaulted of those 175K (7%) where strategic. Strategic default are defined as those people who are more than 20% underwater, keep current with other bills but stop paying their mortgage.

The 7% strategic defaults understates the problem. First the trends is up as of last quarter 12% of all mortgage defaults were strategic. Next people who strategically default have different characteristic than others. In particular they are upper income, and have higher income, credit scores, and 50% larger loan balances. Perhaps most importantly when they default they do so when the mortgages are further underwater meaning the mortgage holders lose even more money. Of those people who's house value dropped 50% or more from the peak 17% of the defaults where strategic.

I estimate that 10% of the mortgage loan losses were due to strategic defaulters. Going forward probably 15-20% of all mortgage losses will be due to strategic defaults. I can safely say that simply based on Freddie and Fannie bailout/losses, folks likes Alex Pemberton and Susan Reboyras, have resulted in additional $150 per household increase in US government debt and that will double in the next year or so.

My SWAG (scientific wild ass guess) is that for the hypothetical $1 million ER portfolio strategic default have cost ~$10K in real not paper losses.

I'm not sure this is a real problem in your mind, it is in mine.

 

[Hamlet]

Thanks for the link. It was an interesting article.

I think there is a fundamental problem with their definition of strategic default, though.

Their definition implies that the ability to keep current with other bills would mean that they also have the ability to pay the mortgage, but choose not to.

There are going to be a ton of people for whom that is not true. Say you have a family in California, husband makes 100k, wife makes 50k, they have a 500k mortgage, 10k in credit card debt, and a 10k car loan.

If the husband loses his job, they are not going to be able to make the mortgage payments, but they may very well choose to keep the other bills current. I know I would, just to minimize the number of bill collectors hassling me.

This family would be counted as a strategic default in this study, but I don't think they are really what we have been talking about. They have no real way to continue paying the mortgage.

You said below that the strategic defaulters had higher incomes, but I saw nothing in the study that indicated that they knew anything about current income. They were looking at the current credit score, but that doesn't mean that the borrower hasn't had a large drop in income. In fact, I would expect that a person with a high credit score would have a higher tendency to default on just the mortgage if they had a large drop in income, while continuing to pay the other bills.

I don't think that you can determine whether a default is truly strategic without determining the borrower's current income.

You've want data. I thanks, to Google, have data.

Morgan Stanley recently published a good study called Understanding Strategic Defaults. In this study they looked at 6.5 million recent mortgages of which 2.5 million had defaulted of those 175K (7%) where strategic. Strategic default are defined as those people who are more than 20% underwater, keep current with other bills but stop paying their mortgage.

The 7% strategic defaults understates the problem. First the trends is up as of last quarter 12% of all mortgage defaults were strategic. Next people who strategically default have different characteristic than others. In particular they are upper income, and have higher income, credit scores, and 50% larger loan balances. Perhaps most importantly when they default they do so when the mortgages are further underwater meaning the mortgage holders lose even more money. Of those people who's house value dropped 50% or more from the peak 17% of the defaults where strategic.

I estimate that 10% of the mortgage loan losses were due to strategic defaulters. Going forward probably 15-20% of all mortgage losses will be due to strategic defaults. I can safely say that simply based on Freddie and Fannie bailout/losses, folks likes Alex Pemberton and Susan Reboyras, have resulted in additional $150 per household increase in US government debt and that will double in the next year or so.

My SWAG (scientific wild ass guess) is that for the hypothetical $1 million ER portfolio strategic default have cost ~$10K in real not paper losses.

I'm not sure this is a real problem in your mind, it is in mine.

 

[audreyh1]

My recollection is that Congress changed the tax laws last year so a deficiency on default on your mortgaged primary residence is not considered taxable income any more.

I thought this was temporary and will expire soon? Am I wrog?

Audrey