$2 Trillion of Negative Real Estate Equity for U.S. Households by 2010

This WSJ article provides a fascinating insight into the dire state of the domestic real estate market in California. Home-owners who bought during the boom years are increasingly abandoning their negative equity homes and taking advantage of much cheaper rental accommodation, often in the very same neighborhood as the homes with the impossible to service mortgage costs. The article makes the point that "California is one of 10 states that largely prevent mortgage lenders from going after the other assets of borrowers who default."

While the mortgage defaulter may suffer from negative credit ratings for many years, home ownership is a luxury that many home-owners can no longer afford or want to afford.

Some are leaving behind their homes and mortgages right away, while others are simply halting payments until the bank kicks them out. That's freeing up cash to use in other ways.

To appreciate how big a headache this could become for the various financial institutions that are entangled in all of the defaulting mortgages, the article cites the following:

Analysts at Deutsche Bank Securities expect 21 million U.S. households to end up owing more on their mortgages than their homes are worth by the end of 2010. If one in five of those households defaults, the losses to banks and investors could exceed $400 billion. As a proportion of the economy, that's roughly equivalent to the losses suffered in the savings-and-loan debacle of the late 1980s and early 1990s.

Although not spelled out, the implication from the above is that there would appear to be at least $2 trillion worth of negative real estate equity for US households by 2010. That fact alone will act as a considerable dampener to consumer confidence for years to come.

Comments

[woollyB]

Not that it took much foresight, but I've been predicting for months that it's only a matter of time before huge numbers of homeowners in the non-recourse states start throwing in the towel. It just doesn't make economic sense to keep throwing away money just to serve your credit score or your moral obligation to repay loans.

The ice looks to be breaking, and this is a very scary development.

2009 Dec 10 03:22 PM

[schlumpf]

why they don´t make it like the banks. Gov-money for 0 % and buy stocks or bonds. Stupidity - these guys.

2009 Dec 10 03:44 PM

[cadoggy]

Walking away from an underwater mortgage is one of the smartest things a savvy homeowner can do to help himself and his family.

The benefits include not paying a mortgage for 12 months, not paying property taxes, not paying a Realtor to sell the home, and wiping out the negative equity that could take a decade to come back.

The disadvantage is that an arbitrary number created by some unknown person at a credit rating agency will ding your credit score. You'll still qualify for par rates on FHA loans in only 3 years! I know because I just sold a property to buyers who meet this description!

2009 Dec 10 05:58 PM

[Tay]

The other disadvantage is that your bank can sue you, get a judgment, and attach the judgment to your other assets and garnish your wages to help make up for the shortfall.

While the loan is backed by real estate, it is still a loan and the borrower is responsible for paying it back, even if the real estate becomes worth less than the loan balance. People have this problem all the time with auto loans.

2009 Dec 11 01:34 AM

[cadoggy]

Tay, in California and some other states purchase money loans are non-recourse. Therefore, you walk away owing nothing and any lawsuit filed against you is quickly dismissed.

It's the one law in California the legislators actually got right!

2009 Dec 11 12:59 PM

[DTafs]

This is what I don't understand about the argument to strategic foreclosure:
-A home's value is only a value if a) you are ref-ing to take cash out or b) buying or c) selling. Otherwise, it's speculative paper money. So someone may value your home less than what you owe, but to the average family, the doesn't represent reality. It's only worth less on paper.
- For the average American on the street, a home represents much, much more than a return on an investment. Take equity out of the equation for a moment, and a home represents family, stability, identity.
- I get the moral argument, but only if you are not in fact a homeowner, and are in fact an "investor." I believe that there is a difference between the two that should be delineated.

I dunno, maybe i'm naive, or have an "old-school" view on property (based on how I was raised), but the reality is that (IMO) most people aren't buying/selling homes on a year in, year out basis. They buy, live, and generally upgrade when needed. At least, that was the playbook I learned from my parents.

I don't feel bad for the people who bought homes primarily as investments over the past 3 years. If they had the foresight to consider that an equitable source of return, they should have had the foresight to understand that when its' too good to be true, it's to good to be true.

2009 Dec 11 01:07 PM

[Clive Corcoran]

WoollyB.

Good observation. Also it's hard for a distressed home owner to feel morally obliged to honor a loan commitment when so many other mega financial institutions appear to have no qualms about re-structuring their obligations.

DTafs

I'm not sure that I follow the logic of your argument. The "home" may represent a source of stability and identity as you suggest but does it have to be owned via an upside down mortgage or could it be more economically rented.
Large debts are being written off all of the time by financial firms based on "miscalculations" about asset values during the bubble years. It seems more and more people in states like California are using the same tactic faced with their own "miscalculations" made into purchasing homes that were not worth as much as they thought and for which they can no longer service the mortgage.

2009 Dec 12 04:17 AM

[John Lounsbury]

DTafs - - -

Clive didn't mention it but there is a fourth reason why the underwater homeowner could have to face the actual value of his home besides the three you mentioned.

If the homeowner has a variable rate mortgage with higher payment resets, he may not be able to service the new payments. He may be in trouble if the initial loan period was any one of the following:

1. Interest only until reset;
2. Very low initial period interest (say 3%) resetting to much higher rates (say 6%);
3. Any other low payment agreement for the initial period before reset to much higher payments.

The assumption that many made before 2006 was that the appreciation of the property purchased would enable refi into an 80% fixed mortgage before the initial payment period was complete. When prices went the other way, that remedy was removed. The home owner can still refi but often has to bring cash to the table to do so. Many overextended their finances to buy the home and now can not handle increased mortgage payments or raising capital to refi into an affordable fixed rate.

Here is a hypothetical example:

Mr. and Mrs. X bought a home for $400,000 in 2005 with a 3% 5-year term 100% mortgage, which resets to 6% in 2010. The market value of the house is now $300,000, so the 80% loan value would be $240,000. If they can get an FHA mortgage at 96.5%, the loan value is $289,500. The balance on their initial mortgage (at 2010 reset date) is $358,840.

When the house was initially purchased the mortgage payment was 34% of total income. After reset it will be 46%. The Xs can not afford to spend $27,744 of their $60,000 income on mortgage payments.

If they were to refi into a 30-year fixed at 5% the monthly payments would be $1,554 (assuming the 96.5% FHA mortgage for $289,500). This is affordable at 31% of income.

However, to get this mortgage the Xs must raise $69,340 to bring to the closing ($358,340 payoff balance for the original mortgage minus the $289,500 new mortgage). Most people in the Xs situation have no such financial nest egg and can not afford the additional payments if they were to borrow that amount.

In the rare event that the Xs do have the resources to put an additional $69,000 into their house, they may chose not to do so. They may reason that they are not likely to get much of that back if they sell in the next ten years. They have lost no equity so far (they put no money up to buy the house) so they may decide they have nothing to lose and $69,000 to gain by walking away or submitting to foreclosure.

This is why millions of homeowners have entered the foreclosure process and millions more are waiting in the wings. There were 10s of millions of homes sold in the bubble and many of these have people trapped in mortgage contracts they cannot service and the refi escapes envisioned when the homes were purchased no longer hang together financially.

This nightmare is one that many Americans do not have to face and have no appreciation regarding the hopelessness it engenders. For millions, though, it is a living nightmare.

I have not even mentioned the case of the person who has lost employment and can no longer make his fixed mortgage payments. If he bought in the bubble, he is highly likely to also have negative equity and can not sell to escape unless he gets a short sale approved. This person falls into category c) in your comment, DTafs. There are over 15 million officially in the ranks of the unemployed, plus another 2-3 million that have simply disappeared from the labor force. There are certainly at least a million (and probably much more) that fall into your category c), not by choice but from economic necessity. Most of these people can not exercise the sale (they can't pay for their loss at closing) and so they enter the foreclosure process, either by walking or by being served papers.

DTafs, you are obviously a person who has not made the bad financial choices of the millions we are talking about. Good for you.

2009 Dec 12 01:42 PM