After a four-year climb in popularity, the homeowner practice of strategically defaulting on an underwater property and walking away may have crested. Fannie Mae has established new restrictions on the availability of future mortgage money to strategic defaulters.
A recent Experian—Oliver Wyman Market Intelligence Report concluded that 19% of national mortgage defaults in the second quarter of 2009 were strategic. This is comparable to the 21% of strategic defaults for the first quarter of 2009. In California, strategic defaults totaled 45,380 in 2009, and continue to be 80 times more common than in 2005, the last year for rising real estate prices.
Many regions of the country are experiencing a stabilization of home prices and a drop in the rate of mortgage delinquency — both factors which keep most of the nation’s homeowners from strategically defaulting. Foreclosures and mortgage modifications will continue to weed out problematic loans, keeping the delinquency rate constant. Nationally, mortgages that were 30 to 60 days delinquent only accounted for 2.4% of all loans during the first quarter of 2010. The most problematic loans were originated in 2006, but the majority of them have already been refinanced, modified or foreclosed on. However, adjustable rate mortgage (ARM) resetting will be an issue to watch in 2011.
Fannie Mae is also closing in on strategic defaulters by enforcing harsher standards for homeowners who may want a new mortgage in the future and showed no willingness to negotiate with their current lenders to stay in their homes. Previously, anyone entering into foreclosure on a Fannie Mae loan would have had to wait five years before obtaining a new Fannie Mae mortgage with a minimum down payment.
Changes from July 1, 2010 now allow a homeowner who attempts a “graceful exit” through short sale or deed in lieu of foreclosure to qualify for a new loan after a two-year penalty period if he has a 20% down payment. Homeowners who are unwilling to work with lenders and stay in their current homes must wait seven years before obtaining a new Fannie Mae loan regardless of the size of their down payment or their loan-to-value (LTV) ratio. Freddie Mac may institute a similar penalty period. [For more information regarding current Fannie Mae penalty period adjustments, see the May 2010 first tuesday article, Penalty period after default on Fannie Mae loan shortened.]
first tuesday take: As the rhetoric of government officials and lenders persuade homeowners to consider strategic default a moral outrage, it is important to view the practice for what it is — a business decision, albeit one the issuer of the put option does not want to honor.
Making payments on a negative equity home with a very poor chance of ever recovering a positive loan-to-value ratio (a maximum 94% LTV) rarely proves wise, if it were even possible. The past money placed in the home is a “sunk cost,” an investment that under any present or future economic or financial condition cannot be recovered. Thus, the past, including the upside down mortgage, cannot be taken into account going forward. A negative equity requires a fresh-start review of a family’s housing needs.
Furthermore, placing the responsibility for negative equity entirely on the shoulders of homeowners with eyes bigger than their pocketbooks is misguided, as well as short-lived. The mortgage market has been left undisciplined by federal regulators and spoiled by Wall Street Bankers – as has always been the case historically – who don’t know or don’t care where to draw the line. Homeowners do not have lobbyists or public spokesmen.
Homeowners should never agree to mortgages they know they will be unable to pay, the so-called Zero Ability to Pay (ZAP) loans present in the market as early as March 1982 when the Treasury introduced them as ARMs concurrent with the regulatory demise of loan assumptions. However, it is unfair for the gatekeepers of the real estate industry to allow lenders and (other) government officials to place moral pressure on homeowners who cannot be held accountable for the facilitating missteps taken by the government.
By using the implicit put option built into the terms of every trust deed, a homeowner has the legal right to default on his purchase–assist home loan and force his lender to take back property for the balance due on the loan, and without recourse.
Strategic defaulting will save tens of thousands of individual California homeowners hundreds of thousands of dollars. With the savings, they will be able to help the real estate market rebound by reentering the homeownership market, as others besides Fannie Mae will certainly finance them. The increased spending of these born-again homeowners will also assist California’s consumer economy. Both are positive results of a prudent business decision by homeowners – if done en masse, neighborhood by neighborhood, city by city. [For more information regarding strategic defaults, see the January 2010 first tuesday article, “To default, or not to default: that is the question.”]
Re: “Seeking to close off an exit” from the New York Times