Premium borrowers may be even more likely to default on their mortgages than subprime homeowners, according to a study released by Fair Isaac Corporation (FICO).
Currently, the mortgage default rate for all homeowners nationally is 4.5%. The rate for premium homeowners is 0.32%. Traditionally, borrowers were far more likely to default on their credit card than on their mortgage loan. Now the increase in mortgage loan defaults is starting to overtake credit card defaults. In fact, only 0.12% of premium homeowners are defaulting on their credit cards – a percent nearly three times less than mortgage loan defaults among this high-end group.
Why are homeowners paying off their credit card debt before the debt linked with their homes? The answer is obvious: homeowners who are financially capable of making their mortgage payments are deliberately defaulting, choosing not to repay their home loans due to the depths their houses have sunk underwater – the negative-equity asset phenomenon.
first tuesday take: This trend of defaults among the wealthier class of homeowners is not news to anyone watching default and foreclosure trends among the different tiers of home values – low-, mid- and high-tier prices. Defaults brought on by negative equity are not the exclusive domain of subprime homeowners and have never been. 30 years of deteriorating underwriting standards came to allow toxic adjustable rate mortgages (ARMs) to masquerade as real estate loans and contribute greatly to the housing crisis California is currently experiencing.
The fall in housing prices is the real estate market’s greatest enemy – prime borrower defaults evidence the invasiveness of falling prices now that wealthy neighborhoods are under attack. Here we see rational, well-educated and wealthier homeowners with above average credit scores realizing that dumping good money into a bad asset is simply an unacceptable waste of hard earned income. High-tier homeowners are now deliberately defaulting on their mortgages, purging themselves of the negative equity that has accumulated due to the massive overbuilding in the 2000’s, lack of homebuyers and the decline in the price of their homes.
Disregarding the intellectual reasons behind mortgage defaults, it is important to note that negative equity does not discriminate based on credit scores, and credit scores do not assure a mortgage lender that mortgages with a loan-to-value (LTV) ratio in excess of 94% will be repaid. [For more information on the underwriting standards lenders have employed over the past decade, see the April 2009 first tuesday article, Lenders vs. owners in 2000-2010: the real estate interest of each.]
The logical resolution for our current California market chaos is a return to the fundamentals of enlightened lending: a significant down payment of 20% to 30% by homebuyers (40% for investors) calculated on a price set by the “historical trend-line value” of the real estate given as collateral – not bubble market comparables (CMA).
Also, the structure for financing real estate must return to the long-term fundamentals of a fixed rate of interest and a 30-year term with monthly payments limited to 31% of consistent homeowner earnings, not the unacceptable short-term risk of volatile ARM rates and their inapplicable and misleading teaser annual percentage rates (APRs). Only after returning to mortgage lending fundamentals, which in turn will better prepare buyers to emotionally and mentally manage their family’s shelter as an owner, will lenders have the assurance homeowners will repay their mortgages.
Re: “Even High-Score Borrowers at Risk of Mortgage Default,” from the New York Times.