Foreclosure Crisis Update

Is the foreclosure crisis over? Yes and no. Since 2007, about six million homes have been sold at foreclosure sales (Foreclosures Public Data Summary Jan 2015). Today, about one million homes are still somewhere in the foreclosure process. Homeowners behind in their payments have declined from 15% at the 2010 peak of the crisis to less than 8% now (MBAA delinquent plus in foreclosure at 12/31/14).  Most of the still-troubled loans were originated before 2007. The best news is that new foreclosure starts are now down to pre-crisis levels, at less than one-half of one percent of all mortgages, if we take 2006 to be the pre-crisis level.

So new home loans, those made since 2008, are doing very well, and what remains is the legacy of those bad loans that triggered the crisis, right? Not exactly. 

The first problem is to define what we mean by pre-crisis levels. Subprime mortgages expanded rapidly from 2000 to 2007, accounting for an ever-increasing share of all mortgages, and skewing delinquency rates upwards. So for a real pre-crisis baseline, we need to go back to earlier times, or to look at mortgage default rates for prime and FHA loans only. Today in 2015 there are virtually no subprime mortgages being originated. As the inventory of old subprime loans winds down, we should expect to see default rates well below those for the early 2000s, and we are not there yet.

The second problem is negative equity. At the end of 2014, 16.9% of residential mortgages were underwater, i.e. the debt exceeded the current home value. Home price appreciation is not projected to solve this problem any time soon. This situation is historically unprecedented, and leaves millions of homeowners at continuing risk of default should the economy falter.

The third problem is the fragile inventory of nontraditional and modified loans that remain from the subprime bubble. There are perhaps 3 to 4 million active mortgages that were modified to avoid foreclosure in the past seven years. Some of these have temporarily low rates, as low as 2%, that will adjust upwards soon. Others have large balloon payments or payment terms than extend for 40 years, making repayment or refinancing difficult.  And of course there are still plenty of homeowners stuck in non-amortizing mortgages or ARMs that are vulnerable to coming interest rate hikes.

At this point, we can begin to identify some lessons from the long and painful process of deleveraging America's homeowners. In future posts I hope to look at some available data showing what worked and what didn't, as we consider various policy measures to reform housing finance and mortgage foreclosure.

Comments

[John]

Sorry Alan, you do not have a clue. Since all the loan documents were shredded and there are no securitized debts, your numbers are so far off it is insane to even guess at it.

[Robert White]

After listening to oral arguments and reading the transcript in BofA v Caulkett I don’t believe the Supreme Court will expand lien stripping to underwater 2nd mortgages in Chapter 7. The most troublesome objection the Justices expressed (except Scallia) is the recovery of equity over time in junior mortgages, which seems to write terms and consideration into section 506 that do not appear in the statute. It would be ironic for the High Court to rule that a lender’s bargained for interest in the collateral was enough to preserve value under section 506 so as to prevent lien stripping. This irony might then set up challenges to lien stripping in chapter 13.

[Thomas Cox]

A fewf comments:

The 16.9% underwater number demands a definition of the term “underwater". I believe that it is used here to simply mean homes where the total debt exceed the fair market value of the home. For a homeowner who wants to move to find a job and thus to sell his or her home, that homeowner is effectively underwater if the value of the home is not greater than fair market value plus a 6% sales commission plus the amount of a 20% downpayment for a new home. The percantage of those homeowners must me far more then double the 16.9% referenced by Alan.If one of these people who has equity in absolute terms loses a job or suffers some other adverse “life event” that person will be unable to sell and will be at substantial risk of going into default and foreclosure.

Second, I suspect that the 16.9% number applies only to first mortgages and that when second mortgages and HELOCs are taken into account the percentage of absolute underwater homeowners is much higher.

Third, Alan does not mention the billions of dollars of HELOCs outstanding that have been on an interest only payment arrangement for ten years are now starting to face full amortization resets.

I think that the foreclosure crisis remains a long, long way from resolution.

[debt serf]

I've seen plenty of awful loan modifications. All the loan mods do is kick the can down the road, and push the problem a few years out. I've just started to see loan mods default a second time as the homeowner just decides to walk away (primarily those with a chapter 7/13 discharge under their belts).

The legacy of the foreclosure crisis will continue for another decade in my opinion.

[Knute Rife]

There are a number of things that need looked at in more detail here or else the numbers are meaningless. For example, on the loan status side, 1) if the loan was in arrears and is now current, how was it brought current, and 2) if the loan is current, how is it being kept current? If either involved an accounting sleight-of-hand (including government-subsidized deferrals and write offs and the IRS ignoring massive violations of the REMIC laws) or incurring additional debt, the problem hasn't actually been solved, has it? On the market side, the underwater mortgage problem is a lot bigger than it's being represented here. First, it's questionable practice to rely on Zillow. A significant percentage of its data seems to have popped out of a rabbit hole straight from Wonderland; since its glowing opinions are based on these data.... Second, since the Boomers are starting to downsize and Generations X and Y face profound shortages of work that produces family-supporting income over a meaningful time, where will the demand come from? Either everyone will continue to want to buy but be unable to do so, or we'll start cooking the loan applications again, which isn't exactly a solution.

[John]

Lets not forget the two elephants in the room, Fannie and Freddie. What is to become of them and what will happen when interest rates start climbing again? They only thing that is known is that no one knows the size of the problem nor the ways in which the problem is interwoven with other elements of the economy.

[Jim]

Of course inflation is exactly what will cure the problem. So expect interest rates to rise and the value of these properties to increase.

[Evelyn Wickham]

I've lived this. Bought the least expensive home in the best neighborhood I could afford, in Florida, in 2006. Put over 20% cash down. Mortgage payment (including taxes and insurance) was far less than the suggested 28% of gross monthly income. The house next door had been bought by flippers, who had transformed it from top to bottom. I had a moment of concern when, as we looked at the house with our real estate agent, he mentioned that the house was priced the same as his soon to be completed, brand new spec home in the more glamorous side of town (Wells Fargo had given him a spec loan, no money down, and by the time his house was built, the market had crashed, he lost it, as did most of the other real estate agents who had also become investors.) But I proceeded anyway. After all, even though the house was older than the agent's new spec home, it was a custom house, in a well-respected neighborhood, on the kind of large lot not seen these days. And we needed a house to live in. I was being conservative with price, I was playing by traditional rules. What a mistake.

Anyway, come 2007, the market was crashing, and by early 2008, my spouse was dealing with a major health crisis. Enormous medical bills and loss of income. In any other market, we would have sold the house immediately, even being willing to lose a few thousand. But, no, could not do it this time, because we had not just lost a few thousand dollars. Our home now had a market value $200K less than our purchase price. Our 20% cash down evaporated in an instant. We immediately stopped making any improvements. It made no sense to pour money into the house. The flippers next door failed to get their beautifully restored home on the market soon enough, and it was not long before the sheriff showed up. Since 2008, that house has been bought and sold four times. The first foreclosure price was $250K less than what had been the market value. With each subsequent sale, the new valuation has barely budged. The house sold again a few months ago, and the 2014 buyers paid the same as the 2008 buyers who snatched the house in a foreclosure.

Since we could not sell our house without coming to the table with $200K, we stuck it out as best we could. We were able to get a loan modification early on to drop the interest from 7% to 4%. And as nice as that was, the effect of those escalating medical bills and loss of income prevented that interest rate reduction from making much difference. We got behind, then pulled out 401K to get a reinstatement (paying the extra taxes and penalties.) Throughout this time, we were not spending a dime on anything extra. We paid off all of our other debts, and had no credit cards and had two paid-off vehicles. I budgeted monthly, then weekly, then daily. I mastered buying a week's worth of groceries for a family of 5 at Aldis with $40.

We started to get some traction once the first reinstatement was processed. Continuing with this very frugal lifestyle, and attempting to save as we continued to pay enormous medical bills, we were surviving. We were in much better shape than neighbors of ours who were going into foreclosure. But two years later, the health issues were not fully resolved, our medical expenses were rising, and we were still stuck with a house worth $200K less than what we owed. Other neighbors were doing strategic defaults and just walking away (and why not when many had been allowed to buy their homes with zero down - they never had any skin in the game.)

We might have walked away, too, but for the ethical issues involved and the practical concerns about protecting a security clearance - get a foreclosure on one's record and risk losing a clearance, and losing the primary income and health insurance. So walking away, or declaring bankruptcy were never options for us.

Despite our best efforts, we ended up late again a couple of years after that, and went through a second reinstatement, again pulling out 401K funds, and paying more taxes and penalties. You might believe we were being irresponsible and spending money on things we should not have been. All I can tell you is that we were spending money to keep the house, to pay our taxes, to pay our medical insurance and bills, to buy the necessities of life (food, electricity, water, etc) After all of that, we were left with very little to put away for the next unexpected emergency. And we did not have the option to put the house up for sale. I kept watching the comps (which were entirely composed of foreclosures and short sales.) No opportunity to sell presented itself.

Again, there was some relief from the second reinstatement. Wells Fargo modified our loan in-house, even adjusting our payment to reflect interest calculated only on the actual current market value (which, from their review, was still $200K less than what we paid.) They extended the length of the loan. What did it matter now? We accepted it because we needed to get through that year, and could not be concerned with years 31-40 (most likely dead by then anyway.)

It's 2015, and we just completed a third round of negotiations with Wells Fargo, because the medical issues have continued (and thanks to Obamacare, our costs have doubled) and the loss of income still occurs from time to time. For the third time, we cashed out 401K funds - the last of them - and Wells Fargo agreed to a repayment plan. We still cannot sell the house. We still cannot walk away. We are stuck. We still spend absolutely nothing on the house - it looks exactly as it did back in 2007. The only people who spend money on any of the houses in this neighborhood are the people who were fortunate to buy right after the crash and through the following years. They are all gungho about spending thousands on new kitchens, new roofs, new landscaping, and they have used the power of the HOA to attempt to make those of us who bought in 2006 spend more money on our houses. The attorneys are the only ones smiling around here.

I was not a newbie to real estate or real estate market ups and downs. I had purchased a house in California in the late 80s, and dealt with the recession then, and the drop in real estate prices (there had been a mini-bubble right around 1990.) It took almost ten years for the price of that house to recover, and while I had to move out of the area long before that for a new job, I was able to afford to keep it as a rental until I was able to sell it ten years later. But that was California, not Central Florida.

I don't anticipate that the market value of my house will recover to the price I purchased it for in ten years, or even twenty years. I bought it with its outdated 80s kitchen, and nearly ten years later, that 80s kitchen is still there, and ten years from now, it will still be an 80s kitchen (fingers crossed that 80s kitchens will be back in vogue then.)

I only hope to turn it into a rental someday, and fill it with a bunch of college students, just as some of my other neighbors have done. Or maybe some illegal immigrants who are flush with their IRS refunds.

I blame the government and the mortgage industry for allowing people to buy homes with zero down mortgages, and then let them cash out tax-free equity which they spent on vacations, new cars, granite countertops. And when everything crashed, they just walked away. To add insult to injury, those same folks are now entering the real estate market again, and, again, with easy money mortgages. And I do hold myself accountable for not being savvy enough to recognize the mortgage system for the corrupt system it was, and is. You can be certain that my kids, who had to live through all of this, understand how corrupt the market is. They already are devotees of Dave Ramsey, rejecting credit cards, and heading to college on full academic scholarships (so no school loan debt), and they plan to save to buy cars with cash, and will wait to buy homes until they can afford to finance those houses with loans with terms less than 15 years.

So, some good has come out of this, I guess. But back in 2007-08, when the crises hit our family, I sure would have liked to have sold this albatross of a house, even with a small loss, so that I could have enjoyed those years with my kids far more, and free of the distraction of financial devastation.