The Real Issues Behind Declining Home Equity Levels

A recent article in the NY Times discussed the growing trend of people walking away from their homes due to not being able to afford their mortgage payments. The trend is discussed within the larger context of changing attitudes around housing, consequences of not having “skin in the game” in the form of a down payment, etc.

From the NY Times:

"I think I could make a case that some borrowers were ‘renting’ (with risk), rather than owning,” Nicolas P. Retsinas, director of the Joint Center for Housing Studies at Harvard University, said in an e-mail message.

For some people, then, foreclosure becomes something akin to eviction — a traumatic event, and a blow to one’s credit record, but not one that involves loss of life savings or of years spent scrimping to buy the home.

“There certainly appears to be more willingness on the part of borrowers to walk away from mortgages,” said John Mechem, spokesman for the Mortgage Bankers Association, who noted that in the past, many would try to save their homes.

In recent months top executives from Bank of America, JPMorgan Chase and Wachovia have all described a new willingness by borrowers to walk away from mortgages.

Carrie Newhouse, a real estate agent who also works as a loss mitigation consultant for mortgage lenders in Minneapolis-St. Paul, said she saw many homeowners who looked at foreclosure as a first option, preferable to dealing with their lender. “I’ve had people say to me, ‘My house isn’t worth what I owe, why should I continue to make payments on it?’ ” Mrs. Newhouse said.

I think that a lot of the analysts and economists interviewed for the article missed the boat as far as their analyses around “changing homeowner behavior”, simply put: whether you fight or leave if you can’t afford the payments, you’re going to lose the home anyway. What the experts are missing is that the foreclosure/walk-away/delinquent mortgage trend isn’t a function of declining real estate values, as it is a function of people who spent well above their means and/or who never should’ve qualified for a mortgage in the first place. While rising real estate values would’ve enabled many people to refinance their way out of trouble, it’s would’ve only been a temporary solution to the long-term issue of affordability.

The only real long-term solution to the affordability issue is a direct subsidy or an increase in income.

The idea that a down payment/skin in the game may cause people to be more willing to fight for their homes is a valid one, but I think it’s more of a measure of whether the person could afford the home in the first place as opposed to causing people to fight harder. People who can afford significant down payments are usually more financial stable than those that can’t. Skin in the game may cause people to fight harder, but if you can’t afford it/never should’ve been approved then the net result is probably still going to be a foreclosure.

I don’t think there should be that much focus on people in homes they can’t afford walking away; instead, analysts, economists and lenders should be concerned about owners who can afford their mortgages walking away due to being upside down. This would be a more disturbing trend as it would indicate that financially solvent home owners would rather ruin their credit than live in a home that isn’t appreciating. As I’ve said in the past, people should be primarily focused on owning a home they can afford and enjoy, not its rate of appreciation.

Finally, I would argue that all home owners that carry a mortgage are “renting with risk” at a certain level, it’s just that some homeowners are more at risk than others. At the end of the day, all homeowners face risk from the elements, financial calamities, declining property values, etc. Perhaps the real change in attitude around housing that needs to occur is the recognition of the costs (mortgage interest, taxes, etc) and risks involved, as too many people view housing as a sort of “financial free lunch”.

Sources: The NY Times: “Facing Default, Some Walk Out on New Homes” – John Leland, February 29, 2008

Comments

[Malkiel]

The important detail that keeps getting lost in these discussions is order of magnitude. People who have suffered a 20% decline on a "normal" (i.e., priced with range of median income) home aren't going to panic and default, while a person who can keep up with the monthly payments on a bubble-priced home may be right to cut their losses if the price of the home was so inflated as to be almost unreachable again in the future. A modest starter home with no advantages (space, location, amenities) which was bought for $800,000 in a Los Angeles neighborhood may be on its way to returning to a $200,000 pumpkin, and the homeowner has no prospect of pulling out hundreds of thousands of dollars in equity again in 10, 20, or even 50 years. Walking away is the only preservation tactic to save that future income in some other retirement nestegg...

[Christian]

It was a homeowner's choice to sign on the bottom line for the liability of the mortgage. So I think it's also a choice for the homeowner to walk away, and realize the foreclosure implications of doing so (credit record hit, future mortgage risk, etc.). The lender is also a fault here for not doing the proper homework in ensure the buyer has enough werewithal to survive paying off the mortgage.

What I DON'T think is right is talk of "bailing out" the buyers who are in over their head. I'm sure there are some wonderful exceptions to this stereotype, but both the buyer and lender are a fault - bailing them out only ensures that the prudent public foots the bill.

[User 162829]

How about a drop in prices to improve affordability?

[User 162842]

What is interesting is that we are quick to blame others but never take on the responsibility of our own. As a mortgage broker my opinion is a little jaded. If I put myself in other people shoes I look at it like this: Just because I qualify for a 300k home from the bank doesnt mean I can actually afford it or want to. If I want to be able to afford other things in life them maybe i settle for a 200k home instead of a 300k home. I think people get so caught up in needing to have the best things they forget about what it means to live comfortablly....look at our nations debt structure if you dont have them money then dont buy it!!!!

[Marty]

Good article and some good comments already. Ill add my own.

Talk about the home ownership/subprime mess is a diversion from the real issue, which is inflation.

Rampant inflation in everything people have to spend money on, combined with wage stagnation or even wage deflation have created a situation where people dont have the money to pay their bills.

It is not "falling house prices". It is the fact the price of almost everything you have to spend money on is going up in price by double digits while good paying jobs are leaving and even those in good jobs are getting modest raises at best.

The #1 employer in Ohio now is Walmart. You are going to get Walmart low prices on housing if jobs cannot keep up.

Here is a comparison I have been trying to get out there.

During the 1970s inflation, the cost of living adjustment to social security totalled 75% from 1976-1984. Other Govt jobs, pensions and even private sector jobs were getting 7-10% increases over those years. When inflation ended, people used their now inflated incomes to pay down their mostly fixed debts.

In the last 8 years the same inflation adjustment totalled 25%. This is way below the real rate of inflation. Outsourcing has kept a lid on remaining job wage levels and in general "downsized" the wage levels of the American family.

Here are some real numbers on inflation. The top set is from AOL news regarding food price increase THIS YEAR ALONE, at the bottom I listed some prices of things in my area of the northeast US.

It is my contention that it is not the mortgages themselves but the increases in the prices of everything else that is leading people to not have the money to pay their bills. Subprime is just the first domino to fall, student loans, auto loans and other consumer loans are already following.

Check out this inflation compared to what the Govt reports..

Here is more of that low inflation for you (source AOL NEWS)

White Bread
Per Pound

Dec. 2006 Price: $1.14
Dec. 2007 Price: $1.28

Increase: 12.8%

Fresh Whole Milk
Fortified, Per Gal.

Dec. 2006 Price: $3.00
Dec. 2007 Price: $3.87

Increase: 28.8%

A Dozen Eggs
Grade A, Large

Dec. 2006 Price: $1.54
Dec. 2007 Price: $2.10

Increase: 36%

All-Purpose Flour
White, Per Lb.

Dec. 2006 Price: $0.32
Dec. 2007 Price: $0.40

Increase: 25.2%

Peanut Butter
Creamy, Per Lb.

Dec. 2006 Price: $1.72
Dec. 2007 Price: $1.88

Increase: 9.4%

American Processed Cheese
Per Pound

Dec. 2006 Price: $3.61
Dec. 2007 Price: $3.91

Increase: 8.3%

Red Delicious Apples
Per Pound

Dec. 2006 Price: $1.03
Dec. 2007 Price: $1.12

Increase: 9.2%

Bananas
Per Pound

Dec. 2006 Price: $0.50
Dec. 2007 Price: $0.53

Increase: 5.2%

Tomatoes
Field Grown, Per Pound

Dec. 2006 Price: $1.64
Dec. 2007 Price: $2.15

Increase: 31%

Iceberg Lettuce
Per Pound

Dec. 2006 Price: $0.90
Dec. 2007 Price: $0.95

Increase: 5.9%

Sweet Peppers
Per Pound

Dec. 2006 Price: $1.89
Dec. 2007 Price: $2.19

Increase: 15.7%

Lemons
Per Pound

Dec. 2006 Price: $1.66
Dec. 2007 Price: $2.05

Increase: 23.2%

Strawberries
Dry Pint, Per 12 Oz.

Dec. 2006 Price: $2.90
Dec. 2007 Price: $3.07

Increase: 5.9%

Broccoli
Per Pound

Dec. 2006 Price: $1.46
Dec. 2007 Price: $1.66

Increase: 13.4%

Sliced Bacon
Per Pound

Dec. 2006 Price: $3.46
Dec. 2007 Price: $3.69

Increase: 6.7%

Ground Chuck
100% Beef, Per Pound

Dec. 2006 Price: $2.61
Dec. 2007 Price: $2.70

Increase: 3.7%

Fresh Whole Chicken
Per Pound

Dec. 2006 Price: $1.06
Dec. 2007 Price: $1.17

Increase: 10.3%

Cola & Potato Chips

Non-Diet Cola, Per 2 Liters
Dec. 2006 Price: $1.14
Dec. 2007 Price: $1.28
Increase: 12.4%

Chips, Per 16 Oz.
Dec. 2006 Price: $3.41
Dec. 2007 Price: $3.65
Increase: 7%

Your Favorite Drinks
Ground Roast Coffee
(Per Pound)
12 Mo. Increase: 18.4%

Orange Juice Concentrate
(12 Ounce Can)
12 Mo. Increase: 13.3%

Red or White Table Wine
(Per Liter)
12 Mo. Increase: 8%

**********************...

Now for some other stats from our area..

Taxes in my town up 86% over 10 years

Gas up 169% over 10 years

Heating oil up 250% over 10 years

Electricity just rose 74% last year for some people but overall up about 100% in ten years.

Cost of full medical benefits for a family at my office up 350% over 7 years

[mytwocents]

This is all the result of a "Perfect Storm"

One gets a mortgage they didn't qualify for. Who's to blame? Borrower or the Lender?v Where's the regulation?

Realtors/Home Builders were doing deals out the wazoo for the past 5 years (or more). There was money to be made!

Infomercials were teaching folks how to flip houses with promises to make $15 grand a month.

Financial advisors were yelling about a "housing bubble" that would eventually burst. Warning against "exotic" loans and such. Remember? But, who was listening to them?

Dinging one's credit score--Who cares anymore? Interest rates and FICO scores are now allowed to be affected by being 1 day late on any other credit account--why bother?

The winds of change has brought us to this mess we have today.

[Stanley]

"The only real long-term solution to the affordability issue is a direct subsidy or an increase in income."

Wrong, the only real long-term solutions is for home prices to drop until they are back inline with incomes.

A subsidy will divert moneys from other gov't programs or need to borrowed. the former will increase unemployment the later will increase real borrowing costs.
Increasing incomes can likely only be accomplished with inflation, by further devaluing the dollar. this will further drive up prices for food, engergy, everything, for all consumers.

both miss the point that housing should be affordable for all, and not a subsidized ATM for the privilaged few that happened to jump onbourd early in the game.

[kenr]

So Marty you are saying you can't make your mortgage payments because the price of eggs are up 36%. Give me a break. I'm sure it has nothing to do with home prices rising 125% in 6 years in some parts of this country due to over stimulated demand.

[Marty]

Kenr, you are focusing on Eggs too much. I deal with real people every day in my business. They are tapped out from price increases. Some have their homes paid off, others have low mortgages. Sub-primes are just a small percentage of the overall mortgages and almost everyone I know is struggling with finances. I do agree the huge price increases are problematic for those seeking houses but not those in houses.

When people lose jobs and are faced with 1000 a month health care premiums, or have 850 dollar a month bills for heating oil and huge gas bills and electricity costs they are in essence carrying another mortgage. Inflation is off the charts. Why do you think gold is going up?

I know retirees that are selling homes that have no mortgages because they are scared they wont have enough money for retirement because expenses have grown so much in the last 5 years.

Marty

[eddieflies]

I knew there was a reason that I didn't want kids when I was married 24 years ago. But, I forgot what it was and now I have a 14 and 15 year old boys. Oh, if only I didn't have the worries and could lead a fun and care free life like my kids. It is too bad that the leaders of our country over the last two decades through away their morals. And with our media fasination and not having any idea what subconsious nero liquistic programming is, the masses of people simply follow one another like sheep. Unfortunately it is not an issue of money, of homes costing to much, mortgages or inflation. It is now the loss of our relationship with our creator. The love of our fellow human being, neighbor, grocer, gardner and everybody else who depends on one another to get up each morning and survive. The lowly middle class person has been swallowed up by big corporations, CEO with rampant benefits and City, State and the Federal Government spending all of our hard earned pension money and taxes chasing a never ending road of wealth. It is time it stops. Our governments have taken our lives and shoved them down the sewer. If only the Housing Bubble were the only problems.

[dectra]

Ok, now MY two cents worth. Some of you have made good points. Prices have gone up. Healthcare cost are rising. Gas is expensive.

But, folks, the bottom line is quite simple: Those who take personal responsibility for their actions will come through this.

Those who want to blame someone else, or shift their cost/burden to anyone other than themselves will always be the losers in this economy, because they won't do what's needed to resolve their problems.