A growing number of homeowners who owe more on their mortgages than their property is worth are opting for "strategic default," which means walking away from their homes, even though they can afford to make their monthly payment.
If the trend accelerates, it could put more empty houses on a market that's already overburdened with vacancies and snuff out any recovery in the moribund housing market.
Right now, more than 10% of borrowers are 25% or more underwater on 4.9 million mortgages. The total valuation could saddle banks with as much as $656 billion of bad loans, according to the latest report from Corelogic.
Banks, with the help of the government, are offering some relief to homeowners who've lost jobs and are unable to make their payments. But those efforts have largely ignored homeowners choosing strategic default and that trend will continue to gain momentum.
After buying their Phoenix bungalow three years ago for $400,000, Jean Ellen Schulik and Danny Kuehn watched its value drop to just $85,000. Even though they can afford the mortgage payments, they felt they were trying to bail out an ocean with a bucket.
"No logical business person would do anything other than walk away," they told CBS News' "60 Minutes."
When a borrower puts 10% (or less) as down payment towards a mortgage it makes it that much easier to "take a hike." Analysts estimate that one in five borrowers who default on their mortgages are able to pay. If that number rises, it could stop the economic recovery dead in its tracks.
Location, Location, Location
Despite some indications that the economy is on the rebound, the housing market is still a basket case.
Loose lending standards in the early part of the decade and back into the 1990s led to wide-scale overbuilding and created a bubble in the housing market.
Now, the country has too many houses and too many homeowners in trouble. Consider:
- Foreclosures are expected to climb to 4.5 million this year from 2.8 million in 2009, according to RealtyTrac Inc., an Irvine, California-based research firm.
- About 7 million homeowners are behind on their mortgages, and that number is on the rise.
- There are now 2 million vacant homes for sale - double the historical level, according to the Census Bureau.
Housing market deterioration is especially concentrated in six states, a wasteland that stretches from Florida to California, each of which have more than 30% of mortgages near or completely underwater. Three states are over 50%, led by Nevada with a whopping 70% of upside-down mortgages.
Generally, these are not states with small populations, with the exception of Nevada, which ranks 35th in the nation with 2.6 million people. Arizona ranks 16th and the other four are all in the top ten.
An alarming total of 11.2 million homes are underwater. An additional 2.3 million mortgages have less than 5% equity. Considering that closing costs for the seller are often 6% or more (mainly realty commission and home inspection expenses), these 2.3 million "near" properties are actually on life support, as well.
If all the negative equity properties were sold it would add up to 13.5 million homes, or 28% of all mortgages.
Government's HAMP Program Ineffective
In response to the malaise in the housing market, the U.S. Treasury department on March 4, 2009 introduced the Home Affordable Modification Program (HAMP). The $75 billion program is majority funded by the Troubled Asset Relief Program (TARP), and charged banks with modifying 3-4 million mortgages to keep borrowers in their homes.
But the program has been entangled with a host of bureaucratic snafus and only about 1 million applications have been filed since its inception. Only 168,708 mortgages have actually been modified, about 40% of which are predicted to re-default.
In a report released on March 25, 2010 the Inspector General of TARP ripped the Treasury for failing to implement a number of moves that would make the program more accessible to a larger number of borrowers while failing to come up with a viable strategy to avoid re-defaults.
More importantly, the report zeroed in on the Treasury's failure to implement modification programs that reduce the principal balance of underwater mortgages, thereby failing to address strategic defaults.
"Owners who have negative equity are about 25% of all mortgages and account for up to 50% of all foreclosures...[this] could be a factor as owners decide to walk away and default in despair of ever being able to achieve positive equity" the report concluded.
Stigma of Foreclosure Fades
In response to the strategic default wave a number of entrepreneurs have sprung up to capitalize.
Among them is Youwalkaway.com, a website that focuses on "Empowering Homeowners Through Intelligent Strategic Default." The company claims to have helped over 4,000 people through the process and offers differing levels of assistance depending on the fee.
Co-founder Chad Ruyle says his greatest challenge is convincing people that they are not immoral.
"The biggest concern people have is the stigma of foreclosing, and what will the neighbors think," he told 60 Minutes. "But...people are realizing now that there isn't shame in defaulting. The banks don't feel shame by foreclosing on a person's home...I mean it's a business transaction."
Brent White, a law professor at the University of Arizona, told 60 Minutes the moral issue is beside the point and, in fact, more people should be walking.
After all, big businesses make such bottom-line decisions all the time, he said. He pointed out that real estate developer Tishman Speyer defaulted on the huge $5.4 billion Stuyvesant Town apartment complex in New York City earlier this year when its value fell by nearly half, making it one of the biggest walk-aways in real estate history.
Improving Economy Only Cure
The lack of moral stigma seems to ring true for a lot of homeowners, especially when the hole they're in leaves little room for hope.
Researchers have found that homeowners will consider default once their negative equity passes 10% of the home's value. They "walk away massively" after they're 15% underwater. And when the equity shortfall hits 50% of the house's value some 17% of households default, even if they can pay the mortgage, The Wall Street Journal's Real Time Economics reported.
Still, that doesn't mean the majority of homeowners who can afford to make the monthly payment will default.
If the economy strengthens and gross domestic product (GDP) can grow at a pace of 2-3% for a couple of years, employment stands a good chance of improving. The economy could add as many as 3-4 million people to payrolls in that time, as evidenced by the government's March unemployment report showing businesses added over 290,000 workers in April.
That should eventually increase personal incomes, improve the psychology of borrowers holding deeply underwater mortgages, and reduce the number of defaults.
And to look at the glass as half full, almost half of the 50 states have less than 20% of mortgages underwater or nearly underwater.
New-home sales also rose in March by 27%, the latest Census Bureau report showed. But most analysts attributed the jump to the pending expiration of yet another government incentive - a tax credit for first-time buyers - and said sales could quickly slump again.
Other analysts have calculated that it could take as long as a decade for inventories to return to their pre-crash levels and for demand to once again exceed supply.
That is a grim prospect for any owner who hopes to rebuild his household equity through rising prices and eventually return to positive territory. That means strategic defaults will continue to be an acceptable escape for many underwater borrowers.
News & Related Story Links:
Negative Equity Report
- 60 Minutes:
Strategic Default: Walking Away from Mortgages
- Office of the Special Inspector General for TARP:
Factors Affecting Implementation of the Home Affordable Modification Program
- Wall Street Journal:
More Homeowners Consider Strategic Defaults
- Census Bureau:
New Residential Sales in March 2010
- Money Morning:
Government Measures No Match for Second Wave of Foreclosures
- Money Morning:
Obama Reveals $14 Billion Housing Program Aimed at Unemployed and Underwater Homeowners