As homeowners are being consumed by the negative equity trend inverting the value of their assets, the number of people choosing to walkaway from their underwater properties is on the rise. Those choosing to walkaway or strategically default (read: voluntarily default on their home loan when they have the means to pay) account for nearly one out of every four defaults today in California.
The concept of walking away from an underwater property that is burdened with a loan in excess of the property’s current fair market value (FMV) is pragmatic and logical. In California alone, over 35% of all homeowners are making mortgage payments on an underwater property with very little chance of building a positive equity within the next ten to fifteen years, or longer.
When a homeowner’s loan-to-value ratio (LTV) exceeds 125%, it takes over a decade of timely mortgage payments for the equity on the property to break even – assuming prices take an upward swing, greater than inflation, and then maintain that trajectory. And this doesn’t even take into account the 6% transaction expense incurred in any real estate transaction. In truth, homeowners need an LTV of 94%, not 100%, to be truly “even.” Needless to say, when the loan amount exceeds that 125% LTV threshold, default becomes the rational financial option – the exercise of the trust deed “put option” California homeowners hold.
Homeowners are beginning to refuse to make large mortgage payments on properties that are now massively underwater, worth 40% to 75% of the amount they originally purchased it for and the amount still owed. Homeowners cannot help but grow depressed as they watch their hard-earned money – money that could be used to rent a comparable property for half or even a third of the mortgage payment – become consumed month after month by a nonperforming asset – their home. [For more information on a buyer’s impetus to walkaway, see the December 2009 first tuesday article, Homeowners, abandoned by government and lenders alike, must wield their walkaway.]
first tuesday take: An irrational social stigma has long been cast on individual wage earners who default on a loan. Not so for investors or businessmen or corporate officers, as they are considered to be acting rationally and in their best interests. While shame and embarrassment have traditionally been tied to wage-earning individuals who have been unable to pay off their debts, these societal labels devised wholly by lenders need to be ignored given the circumstances experienced by over 35% of California homeowners. The more agents, homeowners and the public as a whole talk about defaulting and understand that such a move may well be best for society and the recovering economy, the more underwater homeowners will begin to strategically default. Knowledge provides more certainty about one’s future.
Lenders took advantage of the boomlicious real estate market and encouraged the population to acquire an overly optimistic view about the acquisition of homeownership, the allocation of personal income and the nature of debt and asset wealth. Due to lender exploitation of financially naïve homebuyers and the asset price-push condition referred to as a financial accelerator by which excess availability of property loans drives property prices, our state is now stuck in a resulting surge of negative equity. While homeowners are left to struggle and flounder in this financial violence of underwater properties, lenders are sailing in their government supported cruise ships doing little more than passively viewing their waterlogged victims with general disregard.
Meanwhile, the government, charged with extending a financial life preserver when mortgage lenders panic then seize up in fear, fails to provide real help for California’s population of negative equity owners. The non-political and rather rational Federal Reserve Banks (the Fed) have single-handedly kept the mortgage market open for the past 18 months, which has absolutely propped up home sales during this period. But the political arm of the government has refused to allow federal bankruptcy judges to cramdown mortgages to 94% of the secured home’s value. Alas, Congress has chosen not to force lenders to write down their loan portfolios to the market value of the homes that secures them and book their losses as demanded by internationally accepted accounting rules.
Alternatively, savvy negative equity homeowners can take financial matters into their own hands to escape insolvency. Instead of pouring heaps of money into upside down mortgage loans, homeowners can walk away, saving the money that would instead be thrown into mortgage payments which exceed the rental value of their underwater property. Only then will they be able to begin accumulating down payments for the purchase of new homes, 18 months in the future, when lenders will again blindly extend credit to those homeowners who strategically defaulted to rid themselves of hugely excessive mortgage debt. [For more information on the underwater homeowner crisis, see the April 2010 first tuesday article The underwater homeowner, his future and his agent: a balance sheet reality check – Part I and the upcoming Part II addition to the article.]
Re: “Strategic defaults on homes on the rise” from the San Francisco Chronicle