Strategic Default -- The Big Solution

By
Real Estate Agent with CENTURY 21 MarketLink Realty MN Broker #20444572
http://actvra.in/cf2

Yesterday I wrote about The Big Surprise in which I attempted to make a case for some pre-emptive action by lenders to head off further defaults, specifically voluntary or strategic defaults.  Banks have not publicized anything that indicates that they plan to make any changes in the current way they do business -- they are ignoring the issue.  The anti business, especially anti-bank government is content to wait and watch the problem they foresee as exclusively a bank problem deteriorate.

There are some things that could be done to reduce the number of defaults, and I'll suggest a few.  Please add to the list if you have any proposed solutions. 

  1. Prosecute to the fullest extent of the law.  Most businesses and attorneys general will only pursue the most egregious cases and let the small stuff fall by the wayside.  A harsher stance that would not tolerate fraud and recoverable default would slow down some of the walkaways.  Banks don't like to enforce things that cost more than probable recovery, but there may be some deterrent derived from full enforcement of all legal remedies.  I don't think this will happen, and I'm not sold on the idea that it would make much difference.
  2. Allow move-up buyers to port debt to another home.  The issue here is not whether to allow negative equity.  It already exists.  There are some homeowners who would like to move and have the means to increase their monthly payments significantly.  If banks were to consider a well-qualified mortgagor to move their debt to a new home, the banks could actually improve their position.  Along with a porting agreement could be a stipulation that the homeowner make a substantially higher monthly contribution to the existing principal until the loan to value ratio reaches 80%.  Assuming that the move up buyer is buying a home with the same or greater value, the immediate result would be either the same loan to value ratio or better.  The bank gets a better LTV and a higher monthly debt service.  In the meantime, the higher contribution to principal reduction keeps the homeowner from going further underwater.  The homeowner also gets a home that is more suitable to circumstances and less prone to the ick factor that could contribute to voluntary default thoughts by the homeowner. 
  3. Propose underwater workouts for homeowners who aren't thinking of moving soon.  This seems like another no-brainer for lenders, and it deserves a look.  Start proposing loan modifications for homeowners who are underwater but not in trouble.  The simplest formula would allow a homeowner to voluntarily increase monthly contribution to principal in exchange for a lower interest rate from the lender.  If I agree to increase my monthly payment by 10%, the bank will agree to decrease the interest charged by 10%.  The numbers could be higher or lower depending on the homeowner's comfort level for payments.  The agreement could run until the loan to value reaches 80%, or for a period of time, say one, two, three years to be renewed by mutual agreement.  So, a homeowner with a principal and interest payment of $2,000 would agree to pay $2,200 on their 6% loan in exchange for an interest rate reduction of .6% to a rate of 5.4%.  There would be noticeable progress toward getting back to even relatively quickly.

One or more of these could be implemented with what I feel would be noticeable progress toward getting a substantial number of homeowners back into the housing market, some immediately and some a few years down the road.  Anything that can be done to reduce the number of defaults will help get the industry on the road to recovery. 

 

 

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Ambassador
748,194
Lori Bowers
La Quinta, CA
The Lori Bowers Group

These are all great ideas. Email President Obama daily and see if you get any results.

Jun 11, 2011 09:56 AM #1
Rainmaker
439,798
E.J. "Mike" Carlier
CENTURY 21 MarketLink Realty - Lakeville, MN
Lakeville MN

I'm afraid it would not fit into the administration's plan. Please, tell me I'm wrong.

Jun 11, 2011 10:01 AM #2
Ambassador
1,929,102
Chris Ann Cleland
Long & Foster REALTORS®, Gainesville, VA - Bristow, VA
Associate Broker, Northern VA

You have some great ideas here.  I especially like #2.  Of course, the home buying public wouldn't want to tote that debt with them.  Isn't there some sort of "bank dump" they can dispose of it?

Jun 11, 2011 11:53 AM #3
Rainer
58,089
David A. Weaver
Buckeye, AZ
20 years helping folks finance their homes.

This is not going to go away any time soon.  The investors in MBS are not real excited about giving up their returns by lowering the interest rates on anyone who is current.  Of course our Government fails to recognize that second home owners and investors bought under the rules of the day just like primary residence buyers, but no relief is available to them so I expect that to be the source of a lot of the defaults in the future.

Jun 13, 2011 01:57 PM #4
Rainmaker
439,798
E.J. "Mike" Carlier
CENTURY 21 MarketLink Realty - Lakeville, MN
Lakeville MN

Chris Ann, for most potential move-uppers, the decision is whether to buy a home and port the debt (which they can't do right now), or to not buy a home.  They can still walk away and rent a nicer place, but most will just contribute to the continuation of the stagnant market by doing nothing.  The industry probably needs portable debt more than consumers need it.

David, Many MBS investors understand that there is too much unsecured debt attached to their paper.  Structured correctly, reduced interest in exchange for securing the debt could be very attractive to investors.  My suspicions are that the holders of the investment and second home debt are very nervous.  They should be aggressively proposing workouts to the mortgagors who remain current but are underwater.

Jun 13, 2011 05:24 PM #5
Anonymous
Anonymous
Holly

As a very underwater homeowner, I especially like option #3.  I think your numbers are very scewed though.  If and when I ever get past the moral obligation to pay my mortgage, your numbers wouldn't convince me to stay.  If the Governement can buy the mortgages(Toxic Assets) from the banks, and then sell them to other banks at 70% value and loan these same banks money at a rate of .20% they can get better numbers together for the responsible citizen. 

How about any homeowner that has been current on their payments for a year get a 1% interest rate reduction, 2 years 2% and 3 years 3%, all the way down to the Fed fund rate (the rate the banks get) plus some servicing fee comparable to what they get now (.25% of the outstanding balance).  No principal reduction to the hurt anyone's balance sheet and the servicing banks still gets the servicing fee.  The only loser, would be the person holding the MBS, CDS or other derivitive.  However, my mortgage was written to allow for early pay-off with no penalty so that was a risk that was accepted.  With a low enough interest rate, which the banks are already getting, strategic default doesn't exist because it doesn't make sense anymore.

Of course, it doesn't help the people that could never afford the mortgage in the first place, so no support from the Democrats, and it doesn't help the banks so not likely to get the support of the Republicans either. 

Jun 17, 2011 09:17 AM #6
Rainmaker
439,798
E.J. "Mike" Carlier
CENTURY 21 MarketLink Realty - Lakeville, MN
Lakeville MN

Holly, the program is going to have to be acceptable to lenders, as its nature is voluntary for both parties.  If you continue to make scheduled payments, and if you are a "typical" homeowner who has bought in 2005 with minimum down, you are anywhere between 20% and 50% underwater or worse, it will take at least another nine years to get to almost even, with the debt equal to about the value of the home.  If you're fortunate enough to have accumulated enough savings to pay the selling costs of the home, and to make a reasonable down payment, you (not you specifically, but the average underwater homeowner) will then have an opportunity to change to another home.

Right now, you're paying down about 2.1% per year on your debt.  If your loan is a 5.5% loan, and if you and the bank agree to an accelerated payment and interest reduction in the amount of 20% more monthly payment and 20% less interest, you would get back to positive equity in about four years, not perfect, but at least there's a horizon that is in sight.  Of course, more than 20% increase would further shorten the elapsed time to get to even.

In a perfect consumer world, banks would reduce interest rates to their cost of money plus reasonable expenses.  That perfect world would only exist in an economic system that vested total control of banks with the government.  Somehow, my guess is that the cost of reasonable expenses would degrade rapidly to pay other expenses of government, and we would be even worse off than in our relatively free enterprise system. 

Thanks for your thoughtful comments and suggestions.

Jun 17, 2011 10:18 AM #7
Anonymous
Anonymous
Anonymous

Mike,

Ok, I love number crunching J  I will try to play the devil's advocate to your argument.

I am not sure I follow exactly what the terms of your idea is, but I tried to map out your idea on my situation.  We purchased a 400K house with 10% down.  There are 2 mortgages, between the 2 we have about 327K balance, the house is worth about 280K.  Our monthly payment for principal and interest only (no escrow or taxes) is 2131(principal about 565, interest about 1565 now).  Your suggestion would be a new payment of 2,557.30 and the bank reduce my rate to 4.6% which if carried to the end of the note, would pay my mortgage off in 15 years.   That is an improvement, granted.  However, for a payment of 2,557.30 at the current 15 year fixed rate of 3.25% I can finance 340,000 added to my savings of 50K I can go buy a 390K house for the same money.  If we were to take out a 30 year mortgage at that same payment at todays rate of 4.00% we could borrow 535K, plus the 50K would allow us to buy a 550K home (due to the 10% down requirement! For those amounts, we could substantially upgrade our housing / standard of living.  Not accounting for the moral obligation argument, where is the incentive to stay?

Jun 17, 2011 01:36 PM #8
Rainmaker
439,798
E.J. "Mike" Carlier
CENTURY 21 MarketLink Realty - Lakeville, MN
Lakeville MN

So you're $47,000 negative right now, somewhere around 117% LTV.  In 4.5-5 years, you would be out of the hole with my hypothetical option.  If you were not in the neg eq situation, there are many ways you could spend the bank's money on another home. The IF makes the other options academic discussions at best.

Some folks will walk away from their homes, and some will live for a half generation in their current home, often not a good fit for their families.  It's the homeowners who have the desire and ability to remain owners that my proposal would target.  As I said, many have the ability to make substantially higher payments, just not enough resources to pay to sell their home and make a downpayment on another. 

 

Jun 17, 2011 04:25 PM #9
Anonymous
Anonymous
Holly

Mike,

The typical strategic defaulter has other options and makes a choice.  I am choosing not to argue your comment about the choices being academic, in that I don't believe it brings value to this discussion. As you pointed out in your original post strategic default is happening, more frequently too.  It follows that growing numbers of people are finding better options than paying their current mortgages.    

We both agree that the banks should take some pre-emptive action to head off the growing number of strategic defaults.  Where we disagree is what the proper balance is.  You think that the 20% higher payment and 20% reduction in interest rate is enough to stem the increasing flow of strategic defaults.  I disagree. 

Your comment about the program having "to be acceptable to lenders, as its nature is voluntary for both parties" is very true.  I would point out this discussion was about how to stop the increasing trend of strategic defaults.  The terms need to be favorable enough to convince people to stay if you want to reduce the number of walk-aways.  The more the market declines the larger the incentives will likely have to be.  

The Fed is co-operating with the banks with low Fed Fund rates.  The banks should take the opportunity to refinance the responsible homeowners at these low rates. Yes it will reduce future earnings, but it will make it far more likely that the homeowner will not walk away, protecting the balance sheet.

My money is on the banks not making concessions or incentives of any real value to responsible homeowners and for the housing market to continue to deteriorate.

Jun 18, 2011 08:12 AM #10
Rainmaker
439,798
E.J. "Mike" Carlier
CENTURY 21 MarketLink Realty - Lakeville, MN
Lakeville MN

Holly, thanks again for your thoughtful and convincing observations and comments.  My mention of your choices being academic was a general statement and not directed at you personally.  What i meant was that most underwater homeowners do not have an option to buy another home, or to refinance their homes without coming up with a pile of cash.

The 20% amount was an example of a way someone could effect a workout if they chose to do it.  The number 20% could be 40%, 10%, or anything else agreed by both lender and homeowner.  Likewise, the corresponding interest rate reduction could be a different ratio, perhaps a 30% reduction in rate vs. 20% higher payment.  I still believe that, although not a complete and perfect solution, the option would be attractive to many homeowners. 

Your proposal would be beneficial and would be much more attractive to homeowners because I don't think you have proposed that there be any changes to their payment schedule.  Effectively, it would be a reallocation of part of the interest charged to reduce the principal.

Good luck finding someone for the other side of your bet on the banks doing nothing :)

Jun 18, 2011 09:39 AM #11
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Rainmaker
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E.J. "Mike" Carlier

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