NY Times Article: Enjoying the Fruits of Foreclosure

[brewer12345]

Quote:

Originally Posted by stephenandrew 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]

Quote:

Originally Posted by brewer12345 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]

Quote:

Originally Posted by 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.

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]

Quote:

Originally Posted by brewer12345 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]

Quote:

Originally Posted by brewer12345 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]

Quote:

Originally Posted by stephenandrew 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]

Quote:

Originally Posted by 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"? ... 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.

Quote:

Originally Posted by clifp 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]

Quote:

Originally Posted by brewer12345 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

[clifp]

Quote:

Originally Posted by 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.

I certainly wouldn't behave this way. You missed your credit card payment or more likely make the min payment you get hit with $39 late fee + interest. A missed car payment is probably a $50 late fee. You missed your $3,000 mortgage payment you get hit with 5% $150 late fee and interest. First you burn through your savings than, I think what most people would do is try and juggle the payments, until the husband gets a new job and they can catch up.

If the income loss is long term, the couple runs out of money and miss a mortgage payment. They get the foreclosure notice they call bank and agree to make a payment or even a partial payment.

Once they make an attempt to get caught up they aren't strategic default. You can see this in the data from Exhibit 1 in the report. In a regular default the person credit rating drops before they miss their FIRST mortgage. In the case of strategic defaults their credit ratings increases before they miss their first mortgage payment. Finally most people who defaulted on mortgages still had about 10% equity left when the missed their first mortgage payment vs strategic defaulters who didn't stop paying until their house was 20% underwater. If you had a house worth $550K and $500K mortgage would you really pay your credit card and car loans first and skip your mortgage?.

No measurement is perfect and you are correct that we aren't sure of their income. (Although I think you can infer if strategic defaulter borrow 300K vs 200K for other defaulters and they have higher credit score that they also have higher incomes..)

However if you read the criteria they use to determine a strategic default it seems pretty good to me.

Quote:

We encountered several issues in defining mortgage defaults as strategic. First, we needed to identify borrowers that were current on their non-mortgage payments when they first went delinquent on their mortgage debt. For the purpose of this study, we considered a default to be a strategic default only if borrowers went from current to 30-day, 60-day and 90-day delinquent status in consecutive months without any curing in between or thereafter. In other words, we eliminated borrowers who made full or partial payments at any point after their first missed payment. Even with borrowers who cured their delinquent status and subsequently defaulted, we consider them to have defaulted due to an “inability to make payments” and thus do not consider them to be strategic defaulters. Second, a borrower must have been underwater...

The mom who is giving $8 haircuts to seniors and had medical troubles is a regular default. I am not sure if Alex and Susan count as strategic default or not. The bank screw up and loaned more than their income limits so perhaps they never really could afford their mortgage or not. We also don't know how much effort they made to pay their mortgage.

I am not sure it matters or not. What I do know is they have other assets and income to repay at least some of the money they owe. Borrowing money to live beyond your means shouldn't be rewarded with 18 months of free rent. Putting them in bankruptcy would help repay some of their cost to society as well as serving as warning for the increasing number of people who are considering following in their footsteps.

[Hamlet]

I think you can infer that they had higher incomes when they were originally given the loans. I don't think we know a lot about their current incomes. A credit score isn't going to show if someone has had large change in their current income. Since their current income is what determines their real ability to pay a mortgage, I don't think this study really tells us much about the real number of strategic defaults. I think they are counting a huge number of defaults by people that have had a large change in income.

If a borrower has a dramatic decrease in income (but not to zero), I think a very rational response would be to realize that paying their mortgage is now impossible, but paying everything else is not. If you now have 50k in income, you can pay your day-to-day living expenses, but you can't pay a $3000/month mortgage. Obviously, this is going to make the most sense with large amounts of negative equity, since if you have positive equity you should be able to just sell the house and avoid the whole problem.

I would guess that there are tons of families in California that have gotten themselves into this situation. Stretched to buy a house with two good incomes, and had one of those incomes go away. They have the choice of burning through their savings to make partial mortgage payments and still lose their house, or keep up with everything else and let the house go.

I've seen nothing to indicate that there are actually a large number of people who can still easily afford their mortgages deciding to stop paying them simply because they are underwater.

Quote:

Originally Posted by clifp No measurement is perfect and you are correct that we aren't sure of their income. (Although I think you can infer if strategic defaulter borrow 300K vs 200K for other defaulters and they have higher credit score that they also have higher incomes..) However if you read the criteria they use to determine a strategic default it seems pretty good to me.

[meierlde]

Quote:

Originally Posted by audreyh1 I thought this was temporary and will expire soon? Am I wrog? Audrey

The forgiveness goes thru 2012. It only forgives purchase money mortgages, or home improvements. So if you did a cash out re-fi you get to pay taxes on the balance. Of course if you are insolvent then the total amount is not taxable. Insolvent in this case means sum of debts exceeds sum of assets, and with 200 to 300 thousand dollar underwater folks they may be insolvent. (Including retirement accounts and the like). My guess is that a number of the strategic defaulters are insolvent by this definition.