Negative Equity the Driving Force Behind Subprime Defaults

CreditSights believes that negative equity will be the driving factor in subprime mortgage defaults this year.

In the past, payment shocks such as job loss, health catastrophes or divorce have historically been identified as the primary drivers of default, CreditSights says in US Mortgage Outlook Part 1: State of Subprime. This lack of negative-equity-induced defaults is usually explained by ‘transaction costs’ - which encompass the greater difficulty of gaining credit in future, sentimental attachment to one’s property, moral qualms and moving costs.

“However, most subprime borrowers are already financially stretched even without higher monthly payments. This financial overburdening may mean that the continuing falls in house prices prompts borrowers to wonder whether the sacrifices of paying towards a depreciating investment is economically sensible. Given that it is almost certainly cheaper to rent an equivalent property and that subprime borrowers are unlikely to be losing much in the way of credit score from a default, it is increasingly difficult to see how ‘transaction costs’ can provide much of an argument against defaulting.”

As a result we believe negative equity is playing a progressively more important roll in determining whether borrowers are defaulting.

“In fact, evidence that negative equity is playing a more important roll in borrowers’ default decisions may be suggested by a dramatic rise in realized losses. In September 2007, realised losses on first-lien loans in the ABX indices were roughly 25%.”

Comments

[sbrunton1956:]

To default simply because of negative equity takes impatience past stupidity all the way out to financial ruin.

Maybe some people are just too stupid to own a house.

Jan 13 04:09 PM

[cadoggy:]

I only needed to read the title of this article to get a Hell Yeah from me.

People might have gotten into these loans without thinking too hard but I guarantee you that they won't leave as foolishly. You don't need to be Robert Shiller to understand that your housing equity is not coming back any time soon and that rents are becoming ever more affordable.

Besides... who needs a credit score in the next 4 years anyway? I'm approaching 800 on my FICO but I'm still being denied new credit card offers and have no desire to purchase any real estate until the dust settles.

Underwater homeowners should walk away en masse unless their true desire is to stay put for the next 15 to 20 years. Rip the band-aid off!!!

Jan 13 04:13 PM

[User 336770:]

As a mortgage broker from the sub prime epicenter of southern California (I wasn't one of the bad guys, ehmm), my experience is that negative equity is not the only reason for this crisis.

Much has been made of stated income, nina, ninja, etc. loans. The fact remains that the debt to income levels that were accepted during the boom time for people who could document their income exceeded 55%. Sub prime borrowers who could document their income could have DTI levels from 50-55%.

What is not talked about is that Fannie and Freddie loans could get approved with DTI levels as high as 63%. Typically a borrower would need some other strong factor such as high fico or 6-8 months in reserve. Nevertheless, people are not just walking from their homes because they are upside down. Like most things in life there is rarely one answer, rather a mulititude of factors.

Get ready for the next wave of foreclosures. They will be prime mortgages.


On Jan 13 04:13 PM cadoggy wrote:

> I only needed to read the title of this article to get a Hell Yeah
> from me.
>
> People might have gotten into these loans without thinking too hard
> but I guarantee you that they won't leave as foolishly. You don't
> need to be Robert Shiller to understand that your housing equity
> is not coming back any time soon and that rents are becoming ever
> more affordable.
>
> Besides... who needs a credit score in the next 4 years anyway?
> I'm approaching 800 on my FICO but I'm still being denied new credit
> card offers and have no desire to purchase any real estate until
> the dust settles.
>
> Underwater homeowners should walk away en masse unless their true
> desire is to stay put for the next 15 to 20 years. Rip the band-aid
> off!!!

Jan 13 06:23 PM

[driftwood2:]

Negative equity is a big deal no doubt but I believe that job loss is what will really create a wave of foreclosures this year.

Jan 13 06:34 PM

[cadoggy:]

Obviously negative equity didn't cause this mess because at the beginning of the mess no one had negative equity.

What negative equity will cause is the next wave as stated by driftwood2. Alt-A and Option Arms will default voluntarily and walk away. We're half way through by my measure.

Jan 13 06:37 PM

[brpinion:]

One big reason loans will continue to default in mass is that no one can afford to sell their home. I live in a booming area of atlanta where a hugely successful residential/retail/hot... development broke ground 4 years ago. At that time condos sold by lottery (because there were so many willing buyers) for $430,000 to $490,000 are now being sold in foreclosure between $199,000 and $235,000!

Therefore, no one can afford to sell at a quarter million dollar loss. People can't move for new jobs or if their family expands. I have watched this disaster unfold and wonder if this is happening elsewhere. If you don't believe me look up "Atlantic Station" and the condo/hotel "Twelve" in Atlanta. Check out the prices on realtor.com.

Jan 13 10:46 PM

[Belemba:]

So, if interest rates and Fed rates have dropped so much, how come these savings are not being passed on to mortgage holders?

The drop in interest rates should have ensured that all mortgage holders, including most sub-prime mortgage holders could EASILY AFFORD TO MAKE THEIR PAYMENTS IN FULL EVERY TIME. Instead, greedy bankers are keeping the savings for themselves to help repair their shattered profit stream, with a view to being able to give themselves undeserved bonuses yet again.

Is it time to storm the Bastille again?

Jan 14 01:12 AM

[John Preston:]

Let's see...Chicken or egg?????? Was negative equity the problem which created defaults, or was it the over-leveraged income and declining household spenable income.....whcih created defaults which lead to negative equity?????

Income was over leveraged and when incomes declined, there was no wiggle room....tbw, Fannie AUS would actually issue its best approvals, 100% LTV, minimal reserves, at 64.99%, and that was at the end of 2007...some USER336770 is accurate in his re-iteration of a point I consitently make....which I will explore in an upcoming submission...

Ass for Robert Shiller, he made his case 4 uears ago for addressing housing prices, and warned that a dramatic fall in prices would lead to widespread systemic risk....read his wealth affect study....sucks to be right....

Jan 14 09:10 AM

[mr_subprime:]

I don't think there are nearly as many people walking away from "negative equity" situations as there are families being foreclosed on. Guys like me with commission only income are dealing with a 10-20% decline in earnings. We are now making choices: Life insurance or car insurance?$1500 mortgage or $995 rent? It seems pretty easy on the outside looking in, but anyone who bought a home to provide shelter for their family in a neighborhood fit to raise their children isn't walking because they are "underwater". They're leaving because they are "DROWNING". These folks are being forced out by the lenders (escalating payments and foreclosure) or by the fact that they simply can't afford to own the home and feed their family, too. "Judge not, and ye shall not be judged"

Jan 14 04:18 PM