A couple of weeks ago CoreLogic came out with their negative equity report for the second quarter and once again it showed about 30% of Chicago homeowners with little or no equity in their homes. To be exact, 25.2% are completely underwater on their mortgage and another 5.2% are within 5% of being underwater. That’s pretty much the same as it was in the first quarter.
When people have little to no equity left in their homes they start to exhibit several behaviors that explain a lot of what is going on in the Chicago real estate market:
- They decide to stop paying their mortgages. Why not? They can live there for free for a couple of years before their lender gets around to doing anything about it. And there’s nothing left of their “investment” to protect. Eventually their home ends up in foreclosure and they end up renting since they can’t buy anything with a foreclosure on their record.
- They decide to stay put because they can’t afford to sell – they’d have to write a check at closing.
- They decide to become landlords and rent their place out so that they can cover most of their expenses and move on with their life.
This is a huge impact. While the first behavior actually depresses home prices the latter two behaviors support prices by keeping supply off of the market. If there is ever any sign of rising prices these potential sellers will bring supply back to the market keeping prices depressed for a long time.
Unfortunately, the one thing these underwater homeowners can’t do is benefit from the new lower mortgage rates since their home won’t appraise for enough to get a new loan. So they are stuck paying a high interest rate and for the vast majority of them those monthly “principal” payments are not really building any equity.
Gary, if the government was smart they would allow everyone with good credit, employed, and clearly able to afford their mortgages to refinance into 10-20 year fixed rate mortgages at around 1% interest rates. It shouldn’t matter if they are underwater or not. The money the Fed has spent buying Treasuries probably would have accomplished this. In many cases, borrowers would have payments that are similar to what they currently owe each month on a 30 year with higher rates except they would be building equity. In five years or so we would be out of this mess because existing homeowner’s would have their equity restored and could then sell without taking the loss. In addition, we avoid the moral hazard of principal write downs.
But there is a real cost to doing what you suggest. Either the government is going to lose money on that deal or investors are. On the other hand buying treasuries doesn’t really cost the government anything. In fact, it lowers costs because it drives down interest rates.
No doubt there is a cost, but I don’t think it would be that great . The reality is the current investors get their principal back. So what if they lose the future cash flows, they can invest elsewhere. Fannie/Freddie are already backing most of these loans anyway.
I am just saying if the issue is that homeowners have no equity, then any solution has to address it. This seems to be the least harmful. Borrowers who are serious about keeping their home have a chance to actually dig themselves out of the hole in a relatively short time frame. Banks get underwater loans off their books. The RE market can recover because we don’t have this stalemate of market price to mortgage balance preventing buyers from buying and sellers from selling.
Lower mortgage rates won’t do squat. If you cant afford you home at 5% or 6% on a 30 year, you can’t afford the freaking home. Period. We need to focus on getting mortgage balances reduced without creating a moral hazard.
You may not have seen this earlier post about the costs of such a program: http://www.chicagonow.com/getting-real/2011/09/government-looking-to-steal-money-from-investors-for-homeowner-handouts/ The costs are pretty significant. The issue is that when you own a high coupon fixed income investment in a low interest environment the value goes up. To be forced to redeem it at face value causes you to take a loss. Look at 30 year bonds that are now trading at 140% of par. If the government could redeem those at face value the investors would be screwed.
If it was advantageous for the banks to restructure these mortgages they would have already done so.