10/30/2010

Drowning or Waiving

In the article, Drowning or Waiving, it discusses the issue of many homeowners owing more than their house is worth. Approximately 25% of American borrowers are "under water" creating a difficult situation for the economy as a whole. Areas hardest hit are Nevada and Arizona. Over 4 million households owe at least twice as much as their home is worth. Estimates from 2009 suggest that 26% of defaults were "strategic" in nature. When homeowners default, the property usually is not maintained and the surrounding home values are pushed down. The government is looking at additional ways to fix the problem. The mortgage crisis, however, will not go away until the government supports the real estate market in effective ways. There are many people and groups to blame for the meltdown of the housing market. As a result, these people should bear the brunt of the economics involved. Homeowners that bought more house than they can afford, and are overleveraged, should take the hit and move on. Banks that made the loans should write off their losses and deal with the consequences of making loans to people that really should not have received the loan to begin with. The government up until recently, offered tax incentives to buy homes, such as the $8,000 tax credit for first-time homebuyers. This, coupled with extremely low interest rates, has increased demand for homes but obviously not enough. Homeowners are less inclined to walk away from their home if they have made a significant deposit up front when buying it. It also reduces the total financed amount creating a lower monthly payment, which reduces the chance of default in the future because lower mortgage payments are easier to make than larger ones. Laws and regulations need to be adjusted in the loan process to recognize this. In the long run, taking a more conservative approach to home ownership will benefit not only the individual homeowner, but the economy as a whole.

2 comments:

Dave said...

I wonder about the 26% figure for strategic defaults. This sort of number is common, but it is a description of the end of the problem, not the beginning. For example, is a default strategic if the "owners" have historically had a spending problem? Advocates for both lenders and borrowers tend to avoid this question. There is scholarly evidence that the threshold for strategic default is very high - something like the value being 35% of the loan.

Other than that, I like the whole post.

Plus, I heard a good aphorism about this other day: buying a home without equity is just renting with debt.

Alfred said...

I agree. Mortgage payments are the granddaddy of all payments so if someone has had a history of defaulting on some other lesser payments, then it leads one to believe that maybe the mortgage default was not so "strategic" afterall. There is a good chance that the mortgage default was bound to happen anyway. I know it can happen though. I was talking to a girl recently and she said that her and her husband, both of which have credit ratings north of 750, were trying to decide on whether or not to walk away from their house. She said her husband felt like they were making a bad investment decision and that the bank was not working with them. The husband is a tax partner and a smart guy so I could tell that this decision was really calculated on their part. Her comments kind of suprised me. I don't know their outcome, but I guess strategic defaults really do happen. How many are truly strategic in nature is up for debate, however.