Should You Prevent Foreclosure When You’re Underwater?
A very important consideration when you’re trying to prevent foreclosure is your loan-to-value ratio. This is the measure of what you owe on the home, versus what it’s worth.
This is one of the reasons I ask potential clients what their home is worth. It’s important to make a clear-headed decision on these matters. And taking into account the LTV is an important part of the decision making process when you’re trying to prevent foreclosure.
We’ve grown accustomed, over the last few decades, to having LTV’s that are less than 100%. For years, it’s been assumed that “everyone” had some equity, and it was rare to owe more than your house was worth (at least when you considered the overinflated appraisals that were being issued for the last 8-10 years). But nowadays, many people owe more than their home is worth.
According to an extraordinary article by John Lounsbury, this situation is going to get worse. He says, “It has been estimated that 19 million mortgagees will owe more than their house is worth by 2010. This is 50% of all mortgages.”
This should not surprise anyone, as the general trend is downward, and people are finally waking up to the fact that spending half of your GROSS income on your housing payment is idiotic. Frankly, even the the ratios that Fannie Mae now finds acceptable are absurd.
It’s clear to me that many, many Americans are completely rethinking their spending- what’s worthwhile, what’s not. No asset class or market segment is immune to this mindset.
However, despite popular opinion, many homeowners are much more likely to want to prevent foreclosure and keep their homes, even when they know that they owe more than the home is worth. My experience is contrary to the mythical “ruthless homeowner” who consciously decides to stop making mortgage payments because he’s upside down on his mortgage, rides out a foreclosure and sends “jingle mail” to his lender.
My expectation is that housing still has another 20% to fall from where it stands today.
So, if that’s my key assumption, then why does it make any sense to try to prevent foreclosure and keep your home?
Great question. Here’s my theory.
In my experience, the mortgage industry has an extremely feeble hold on the pulse of the market. I have seen that pretty consistently, the mortgage industry is 18-24 months “behind the curve” when responding to changes in market conditions. Today, they’re “solving” problems that ideally would have been acted upon a year and a half ago.
The level of denial amongst mortgage investors is equal to that of the very homeowners who are trying to prevent foreclosure. I spoke to a very well-connected former GSE official and I was shocked at the fact that while he had a good command over current facts and figures, and had pretty lousy expectations for the economy going forward, his ideas for how to address the problem were completely ignorant of falling housing prices. While he was cognizant of the current situation, his “solution” to the problem of recidivism flew in the face of the facts.
So it’s going to take some time before the mortgage industry really deals with the problem of handling underwater assets. Right now, they’re focusing on how to keep homeowners in homes (to some degree), and deciding on which homeowners to boot out right now.
What they’re really doing is kicking the can down the road. At some point, when the homeowner wants to move, dies, takes a job transfer, can’t afford the less unaffordable, “streamlined” loan modification payment (redefaults?), the day of reckoning will arrive and they’re going to have to figure out how to handle these losses. Because losses will be taken, one way or another.
My expectation is this: in another 24 months, the mortgage lenders will come up with some way of dealing with this issue. It’s not that they’ll want to; they’ll be forced to accommodate reality. To a large degree, they already are, as they’re taking on a fair amount of short sales right now.
“Moral hazard” or not, they’re going to have to make provisions for the homeowner who’s current on payments, but will not pay off the loan in full with a market-value sale. And if they’re going to require the sellers who’ve met their monthly obligations to “pony up” and cover the difference or sign some sort of unsecured note, they’re going to have a hell of a lot of homeowners who just default several months before their move, make no attempt to sell the home, and let the REO division handle it.
The increased losses of that approach will bend the lenders’ philosophy to a more pragmatic solution.
With that in mind, if you owe more than your home is worth but you’d still like to prevent foreclosure and keep the home, here is my advice:
1- Determine how much your home would REALLY sell for in this market
2- Knock off another 20%
3- If you’re comfortable with that- and you buy into my theory- then have your financials reviewed by someone who works in this industry BEFORE you approach your lender
4- Have your loss mitigation package prepared, and begin the loan modification review process
If you really enjoy your home and you intend to stay there long-term, just realize that you’re not going to be seeing any price appreciation for quite some time. Now is the time to begin focusing on paying down your debt, re-structuring your financials, and building up cash reserves… not riding the real estate bull.
Some will say, “Well, then you’re just renting.” And I would agree. But what’s the alternative? Rent somewhere else? Not so fast. If you live in a home at the median value or above, just how likely are you to find a comparable property available for rent? The vast majority of homes for rent are BELOW the median value in any given area. Furthermore, what few units may be available to rent will face significantly increased demand from other foreclosure refugees. And, you’ll be constrained in any changes you may want to make to the property, subject to inspections and a much lower level of privacy and choice.
Oh, and if you think, “Well, I’ll just rent for a few years and then I’ll buy another home in a few years,” I’ve got some questions for you. How do you know? Do you expect it to be easy to obtain a loan? Credit’s been tightening for awhile now, and there’s a lot of clamoring to increase the size of required down payments. Do you have the self-discipline to save 5-10% of the purchase price in just a few years? What if they reduce the debt ratios for future borrowers, and they’ll only allow you to spend 28% of your monthly income on a mortgage payment… or even less? Then what?
Let’s do some simple math. For simplicity’s sake, let’s say that you plan to walk away from your current home, and you think you’ll be able to buy a comparable home for $100,000 in two years. That means you’ll need to save $5,000 in two years. Since savings accounts aren’t paying anything, the entire down payment will come from your contributions. $5,000 / 24 months is $208 every single month. Do you have the self-discipline to save that much each and every month? And not spend it on anything else? I think a lot of people would say, “Yes, I can.” I would say that most Americans can’t. How do I know that? Because very, very few Americans have $5,000 in the bank right now. So you’ll have to do some serious behavior modification if this is your plan. You’ll also have to hope that they don’t require more than 5% as a down payment. You’ll also have to hope that interest rates don’t rise significantly, as many are expecting.
So, if your plan is to cut your home loose and replace it later, you’re going to have to hope that a LOT of factors go your way. If just one of those factors goes against you, your plan may be foiled.
So there’s your choice. You may not like your options, but if you weigh the factors intelligently, you’re more likely to make a better long-term decision. Take all of these factors into consideration before you decide whether it’s better to cut your current home loose or prevent foreclosure and keep your home.
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Tags: Fannie Mae, foreclosure, mortgage, streamlined loan modification