Ask any actively engaged real estate professional and they will confirm the county’s real estate market continues to improve. March sales were 20 percent better than March of 2011 and the most active March since 2006. The county’s median selling price of $252,000 was down slightly from a year ago but was higher than both January and February. Listing inventory is at the lowest level it’s been in the past 10 years and multiple offers on well-priced listings are pretty common.
But wait, there’s more good news. According to a recently released report from data aggregator RealtyTrac, the number of foreclosures has declined to the lowest level in more than five years. With interest rates running below 4 percent and most economic indicators on the way up, why are lenders bracing for a record number of homeowners walking away from their mortgage this year?
FICO, the leading provider of analytics and decision-making technology, known primarily for their credit scoring technology, is predicting the number of strategic defaults is expected to double this year over last. Here’s why.
Although there are clear signs pointing to an improvement in the housing market, this revival will be unlike others, where property values bounced back relatively quickly. There will be no bounce or quick return to the peak values we experienced in March of 2006 when the county’s median selling price was $515,000. This Great Recession has been too deep for too long and just as the Great Depression had long-lasting psychological effects on the generations that lived through it so also will this recession, which has created a paradigm shift in our attitudes about housing and mortgage financing. The extended duration of declining property values and their likely long-term recovery is one reason for the expected increase in the number of homeowners likely to walk away from their homes. Two or three more years of foreclosures, holding in check appreciation, is reason for many to throw in the towel.
Tom, a successful dentist, purchased his home in an upscale El Dorado Hills neighborhood in 2005 for $575,000. Rather than tying up working capital, he chose a zero down payment mortgage. In 2006 he took out a home equity line of credit to landscape the back yard, put in a pool and purchase a boat. Tom is still financially capable of making the payments on his house but like many he doesn’t see the benefit of holding onto a house that is $200,000 underwater and will probably take 20 years or more to get back to its original purchase price.
“Why should I continue to pay over $4,600 a month to live here when we can move down the street and rent basically the same house for $2,500?” It wasn’t so much of a question as a demand for a response.
Tom understood the downside of walking away from his mortgage, called a strategic default. His credit would be ruined, he would be unable to qualify for a conventional mortgage for at least five years and he may face some embarrassment or criticism from friends and family. The upside was he would save $150,000 over five years by renting and loose a $650,000 debt obligation.
Despite the different loan modification programs, some borrowers still don’t qualify for one. Frustrated with their lender, they are walking away from their home and the mortgage. Other homeowners can’t or don’t want to remain in their home. They need to move. Their family situation has changed or they need to move in pursuit of employment. There are still 2 million Californians seeking full-time work.
According to Jon Maddux, founder of YouWalkAway.com, “The majority of clients who walk away from their mortgage share common characteristics: They bought at the height of the real estate market and are now severely underwater, or they need to relocate but are saddled with a home they can’t sell.”
Almost 23 percent of U.S. homes with a mortgage were underwater by the end of 2011. That’s about 11.1 million properties, according to CoreLogic. The degree as to how far underwater the home determines how likely the strategic default. Homeowners who were 25 percent underwater were twice as likely to default as home were owners only 10 percent underwater.
The stigma against strategic defaulters has softened in recent years as more borrowers have successfully walked away from their homes without any significant consequences. Mortgage defaults that were once viewed as shameful or an embarrassment are now considered a sophisticated financial planning option. Former underwater homeowners talk about the amount of debt they dumped or how long they lived in their home without making a payment.
Strategic defaults are not just about financial factors but ideological and emotional.
Many defaulters will walk away from their mortgage because they are angry at their lender. The FICO survey revealed that 44 percent of borrowers felt less of a moral obligation to pay their mortgage if they knew their bank was involved in predatory lending and 28 percent if they realized the bank had received financial support from the government.
Mortgage decisions traditionally have been based upon an analysis of income, debts and credit. The challenge in the future, in light of the strategic default phenomenon, is what additional factors do lenders use to quantify the risk of a future default? Perhaps character? But how does FICO score a borrower’s commitment or reliability? Someday a personality profile may be as necessary as a credit score.
Ken Calhoon is a real estate broker in El Dorado County. He can be reached through his website at kencalhoon.com.