No matter where you look, and which online news service you scan, you are bombarded with stats about the declining housing market and the daily increase in the number of homes entering foreclosure. It’s not only happening in the bubble states (California, Nevada, Arizona, Florida) but nationwide as well.
Calculated Risk featured an update story on the subject in Georgia, while Mish over at Global Economic Trend Analysis reviewed Maryland, Virginia and D.C. housing issues.
No doubt, you have heard about the major efforts by banks and mortgage companies with the blessing of the U.S. government to freeze the foreclosure process for 30 days and/or renegotiate acceptable loan terms with individual borrowers. With some 2.4 million mortgages resetting over the next couple of years, this amounts to a Herculean effort.
If you have gotten the impression that the main purpose of this mission is to rescue homeowners, then you are mistaken. Yes, some borrowers will be helped, many will not. The main purpose is to rescue the banks/lenders from drowning in foreclosed properties. Anytime a lender takes back a home in today’s market, it’s a losing proposition.
Let’s take a simplified example in which I am the lender and you are the borrower. Let’s assume that I made a loan on your home a few years ago for $400k. Your home is currently worth only $300k, which means you are unable to refinance or sell without adding any cash of your own. Note, that this loan was made as a ‘qualified’ loan and not of the Subprime variety but that you are facing a resetting of the adjustable payment.
As many homeowners in this situation, walking away sounds like a plausible solution as you recognize that your choices are limited. You contact me to inform me to ask as to where to send the key to the home as you will be vacating.
Since I have just taken back a few other houses, I don’t really want to end up with another headache. Right now, your loan is an income producing asset on my balance sheet. If you stop payments, this turns into a liability for me, since I borrowed the original funds from an investor to whom I am obligated for the term of the loan.
My goal now is to find out what you can afford to pay and get you to keep on paying it. The old payment was comfortable and you might like my proposal of keeping that intact by me giving you a 2-year extension. What’s the benefit to you other than that you get to remain in the house? None, really, but look at what I as the lender gained:
1. I am still collecting a payment, although lower, on an overvalued asset
2. I don’t have to foreclose, which takes at least 120 days, during which I would not receive payments
3. Once I own the property, I will have to aggressively market it to hopefully sell it at $300k
4. If I finally sell it at $300k, I will have selling expenses of some $23k, netting me only $277k
5. During the marketing and escrow period, I will not collect any interest payments either
6. When all is said and done, my original $400k loan returns to me some $277k at best not counting lost interest payments and fix up costs
As you can see from this small example, negotiating with borrowers to keep them paying on an over inflated asset will do nothing for them, but will do everything for me as the lender.
If you think all these re-negotiation efforts are about helping you as the borrower, think again. It’s not about you; it’s about saving lending institutions that will have to write down assets so fast when considering REOs (Real Estate Owned) in huge numbers, that the liability column on their balance sheets may grow to be larger than the asset side. That, of course, would mean another bank bites the dust.
Even if you extend the same loan terms to troubled borrowers by 2 years, or freeze foreclosure proceedings by 30 days, it will only delay not solve the moment of reckoning.
From my point of view, there are only 2 solutions to this problem. Bring back the garbage loans with low initial payments or give every borrower in distress a $100k/year raise. Yeah right, either one of those are likely to happen.