Most people are cautious by nature waiting for others to pioneer new places, new ideas, and new patterns of behavior. People will observe the results of pioneering behavior, and if the pioneers are rewarded and recommend what they did to others, the herd will follow. If the pioneers are handsomely rewarded and strongly recommend a course of action to others, the herd can turn into a stampede.
The rewards of strategic default has bankers worried. With 11 million underwater loan owners, the last thing bankers want is a wave of strategic default as overextended borrowers realize they can eliminate their debt-service payments with little or no penalty. The onerous burden of housing debt may be soothed by rising prices, but the monthly payments remain. Most who strategically default feel a great sense of relief once they make the decision. And with the first wave of pioneers reporting their good fortune to others, many more will likely do the same.
Baby Boomers & Strategic Default
Survey Study Of YouWalkAway.com Clients In Relation To Retirement & Foreclosure
Baby boomers, generally considered those born between 1946 and 1964, face a myriad of issues as the larger-than-average generation ages. The cohort that demanded an increase in the production of consumer goods – homes included – is now hitting retirement age. This means fixed incomes and reduction in living space requirements. While this is to be expected for anyone hitting the retirement milestone, this has been an especially difficult transition for the boomers due to the reduction in value of dream homes purchased at the peak of the market to house their entire families. Facing high mortgage payments, increased maintenance, and a reduction in income, many of the boomers are choosing to walk away. Many others claim to have no choice.
What surprises me is how many seniors took on massive debts just before retirement. They knew their income was going to diminish, yet they took on huge debt-service obligations. The stupidity in that may be partially explained by kool-aid intoxication and wishful thinking, but it is really irresponsible. I don’t feel sorry for those who took this risk and lost, particularly since they are demanding my generation overpay for housing to bail them out.
Compared with their younger counterparts, baby boomers are generally more likely to have depleted their savings, retirement and other accounts prior to making a decision to strategically default, leaving them with little to no safety net keeping them above the poverty line during what should be their golden years. Many of the clients that You Walk Away works with on a daily basis are in their late 50s or 60s and during a time when they should be planning for a retirement of leisure and relaxation, they are instead consumed with debt, continued unemployment, and a looming fixed income.
From the experience of You Walk Away, in stark contrast to younger generations that saw walking away from an underwater home as a strategic business decision, baby boomers are often more concerned with the negative stigma associated with defaulting on a mortgage contract. Rather than seeing the cost versus reward, they depleted their savings accounts because they had never missed a payment and could not fathom breaking a contract like a mortgage. They weren’t raised this way, and the departure from the traditional view of the American Dream often took some time. However, in that time, many of these Baby Boomers inadvertently removed their own safety net of 401ks, retirement funds and savings accounts in order to maintain an underwater property.
In the below graph, we crossed the data with age bracket
I think it’s sad so many will now endure an impoverished retirement because they didn’t wise up sooner and strategically default while they still had savings. They compounded one foolish decision with another.
One story from a client of ours who created her own blog called “Adventures In Default” stands out. They didn’t deplete their savings, however they saved through the process. She writes:
“It will be 2 years in October our foreclosure was final. Our family is all doing very well now, even Mom. We are so thankful we had to ability to help our family when they most needed us. We have proof, ethically, and every other way, no doubts, we made the right decision. We’re so glad we put our money into savings rather than throwing it away to feel better about keeping a contract to MERS. (Don’t know who MERS is? Neither does anyone else.)
Notice how this borrower had to dehumanize the party bearing the loss. In the days of the community banker, these people wouldn’t have defaulted, but now with the anonymous ABS pool investor absorbing the loss, most people don’t care.
Because we walked, we were prepared for a major family emergency without throwing us back into more debt. Now that our son is here, we sometimes wish we had the space we did in the other house, but, we sure don’t miss the expense of it! And, he’ll only be with us until the end of the year at most. So we choose to be thankful for a home we can afford that’s full of a family who has really pulled together for the things that count most in life. No regrets.”
The defaulters have no regrets, but many who are underwater and hanging on do. They cling to fantasies of principal forgiveness that is not forthcoming.
Some came to us before they exhausted their savings and others came after. Left with little to no savings, an underwater home, unemployment, and the looming thoughts of growing old and potential health problems, the encroachment of the golden years is no longer so glistening. It may me wracked with more stress, anxiety, fear and worst of all, hopelessness.
I wrote that rising home values will halt strategic default. My reasoning is based on the perception of rewards for continued payment.
People bought houses during the housing bubble because they believed they would be rewarded with HELOC money or increasing value in their properties. The housing bust squelched most of these dreams, but hope springs eternal, and many are holding on with the belief the market will eventually make them whole again. The belief in this future reward can push a borrower in either direction depending on what’s happening with home prices. As home prices plummeted, so did borrower’s hopes of ever having equity again. Borrowers without hope of equity often strategically default. If it becomes a widespread perception that house prices are on the mend, the psychological impact on loanowners will be profound. Many who still may not have equity in many, many years will at least see the light at the end of the tunnel. Rising home prices give loanowners hope, and this hope will dramatically change the strategic default equation. In 2013, strategic default will become far less common.
Lenders are desperately praying more people perceive rising house prices are a benefit and ignore the advice of the pioneers. How this plays out with the individual decisions of millions of loanowners will determine how much longer this situation takes to resolve. Liquidating several million more properties of strategic defaulters will weigh on prices for many more years.
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Proprietary Irvine Housing News home purchase analysis
$325,000 …….. Asking Price
$178,500 ………. Purchase Price
6/30/1999 ………. Purchase Date
$146,500 ………. Gross Gain (Loss)
($14,280) ………… Commissions and Costs at 8%
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$132,220 ………. Net Gain (Loss)
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82.1% ………. Gross Percent Change
74.1% ………. Net Percent Change
4.5% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$325,000 …….. Asking Price
$11,375 ………… 3.5% Down FHA Financing
3.53% …………. Mortgage Interest Rate
30 ……………… Number of Years
$313,625 …….. Mortgage
$92,833 ………. Income Requirement
$1,414 ………… Monthly Mortgage Payment
$282 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$81 ………… Homeowners Insurance at 0.3%
$327 ………… Private Mortgage Insurance
$295 ………… Homeowners Association Fees
============================================
$2,398 ………. Monthly Cash Outlays
($211) ………. Tax Savings
($491) ………. Equity Hidden in Payment
$13 ………….. Lost Income to Down Payment
$61 ………….. Maintenance and Replacement Reserves
============================================
$1,770 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$4,750 ………… Furnishing and Move In at 1% + $1,500
$4,750 ………… Closing Costs at 1% + $1,500
$3,136 ………… Interest Points
$11,375 ………… Down Payment
============================================
$24,011 ………. Total Cash Costs
$27,100 ………. Emergency Cash Reserves
============================================
$51,111 ………. Total Savings Needed
The property above is available for sale on the MLS.
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Nearby Foreclosures
Gain a competitive advantage over other buyers. By locating distressed properties -- before they hit the MLS -- you can discover where tomorrow's REOs and short sales will appear. Most of these properties are not listed on the MLS, but they will be soon. Research properties in advance and get a jump on your competition. Don't miss out on another deal because you couldn't act quickly. Use this tool to your advantage! The red properties are already bank owned. As soon as REO asset managers prepare them for sale, they will be on the MLS. Get ready! The green and blue properties have owners who are not paying their mortgages. They may be offered as short sales, or they may go through foreclosure and become REO. Either way, they will also likely be available on the MLS soon. Find your next home! Be prepared to offer on these properties by researching them in advance or risk losing out to buyers who are have done their homework. Start your research today! To find distressed properties, enter your desired location and press search. Scroll through list by pressing "next."Comparative Market Analysis
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$595,000 8 ATHERTON |
0.63 miles 3 bd / 2.25 ba 1,668 Sq. Ft. |
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$609,900 12 CALANDRIA |
0.76 miles 3 bd / 2 ba 1,414 Sq. Ft. |
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$575,000 8 LEESBURG |
0.96 miles 3 bd / 2.5 ba 1,424 Sq. Ft. |
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$550,000 172 GARDEN GATE Ln |
1.04 miles 2 bd / 2.5 ba 1,200 Sq. Ft. |
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$498,000 170 GARDEN GATE Ln |
1.05 miles 2 bd / 2 ba 1,039 Sq. Ft. |
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$549,000 34 STRATFORD |
1.14 miles 3 bd / 2.75 ba 1,273 Sq. Ft. |
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$529,000 4552 CHEVIOT Dr |
1.87 miles 3 bd / 1.75 ba 1,150 Sq. Ft. |
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$649,999 4761 LINDSTROM Ave |
1.88 miles 3 bd / 2 ba 1,500 Sq. Ft. |
Why REO Discounts Vary So Greatly: FHFA
Calculations for REO discounts can differ on extreme levels. In a mortgage market note from FHFA, the agency explained the common reasons behind the variations.
The note stated that REO discounts heard in media reports “are typically found by comparing sales prices of REO properties to prior valuations of the same houses or sales prices of non-foreclosed houses and are generally larger than the discount caused solely by REO status.”
RealtyTrac, which is cited in news reports often, found REO discounts from 2010 to 2012 ranged from 33 percent to 41 percent, according to the note.
The estimates found in the news media are in accord with consumer expectations as well. FHFA pointed to a Harris Interactive survey conducted in April 2011 for an ongoing RealtyTrac and Trulia study, which found American adults expected to pay 38 percent less for a foreclosed house than a similar non-foreclosure.
The academic world, which tends to depend on location, time and controls for estimates, has a discount range that can be anywhere between zero to 50, but most estimates on REO discounts in academic literature fall in the 10 to 25 percent range when looking at nationwide averages, according to the note.
When observing estimates for just one metropolitan statistical area, the variability is even greater since the academic studies adjust for characteristics and property condition.
FHFA stated there are at least six reasons to explain why REO discounts vary so greatly. The first three are the condition effect, characteristics effect, and market effect. Those explanations are directly related to the property value of houses. The last three explanations are: buyer-related effect such as risk aversion, seller motivation effect such as loss aversion, and stigma effect. These are what FHFA called indirect mechanisms.
The condition effect can affect an REO discount since REOs, unlike non-foreclosures, are more likely to remain unrepaired if damaged, such as from inclement weather. Also, some REOs would find a loss in value because of intentional damage left from a previous owner.
The note also stated that REO discounts reported in the news typically don’t account for differences in property characteristics such as age and size when comparing REO properties to non-foreclosures. According to the note, REOs actually tend to be older and have smaller lots than non-foreclosed houses.
The note explained that REO discounts found in media reports also usually compare REOs to prior sales prices or previous assessment values of REO properties or values of non-forecloses from other neighborhoods.
This can have a significant impact on REO discounts, especially during market downturns. For example, during a downturn, a home that sold in 2006 for $100,000 may sell for $80,000 in 2011, even if it’s not an REO. This type of market downturn can inflate the REO discount estimate, the note explained.
The buyer-related effect deals with concerns over risks such as hidden costs, unforeseen delays, and potential loss of property value due to unexpected issues.
Seller motivation can also affect the REO discount. Since servicers have to pay fees such as taxes, insurance fees, and maintenance costs, they have an incentive to maximize the sales price.
In addition, the stigma of REO properties has an impact on the discount.