Thursday, May 13, 2010

Freddie Mac homepage addresses strategic default

Going to the Freddie Mac homepage there is a link to this article:

A Perspective on Strategic Defaults
May 3, 2010 – As the mortgage industry works through a large volume of loan delinquencies, a new and growing concern has emerged: strategic defaults. In other words, borrowers who have the financial means to make monthly mortgage payments, but choose not to do so and, instead, purposely default on their loan.

Strategic defaults come from a variety of homebuyers: from real estate investors who sought to profit from rising house prices during the housing boom, to individual families who simply sought shelter. But these homebuyers have certain things in common: their properties reside in regions where house prices have declined considerably, and the amount still owed on the mortgage is far greater than the present value of the house.

Some in this situation believe they will be forever chained to a large debt owed when they sell the house. And so, even though they have the ability to keep paying the monthly bill, they have decided to walk away from the property without paying off the loan. An intentional foreclosure, if you will.

In essence, these borrowers are weighing the costs and benefits of a strategic default, and coming to a conclusion. Now, the costs can be considerable. Once a mortgage goes into default, a borrower's credit rating is severely tarnished, making it more expensive, if not impossible, to qualify for any new form of credit. In certain states, a borrower's personal assets can be subject to a deficiency judgment. And anything that involves a credit review, such as obtaining auto insurance or getting a new job, can be complicated. These detriments can be in effect for several years. The benefit: the borrower avoids paying for the lost equity in the house.

Knowing the costs and factoring in the time horizon, some borrowers have made the calculation that it is better to purposely default on the mortgage. While I understand how that might well be a good decision for certain borrowers, that doesn't make it good social policy. That's because strategic defaults affect many other families and communities. And these costs – or as they are known in economic jargon, externalities – are not factored into the individual borrower's calculations.

Let's start with the neighbors. When strategic defaults occur, homes go into foreclosure and sit vacant for some period of time. We know from experience that foreclosures and vacancies drive down the property values of everyone else in the neighborhood. Thus, strategic defaulters, in effect, deplete the personal wealth of their neighbors. Get a critical mass of strategic defaults, and broader communities and regions become affected. Indeed,, the analytic firm, recently said that more strategic defaults could tip a fragile housing market back into one of further price declines. Even more families harmed.

But that's not all. Should strategic defaults become more common, mortgage guarantors and investors, including Freddie Mac, would need to factor this risk more prominently into their credit policies and prices. The likely impact on future homebuyers: the cost of a mortgage will go up and credit terms will be less flexible. Thus, the impact of strategic defaulters on still more families might be more expensive mortgages and loans that are more difficult to obtain. The strategic defaulter does not usually consider these costs.

Do borrowers considering strategic defaults have other options? They do. For those who have not suffered any disruption in income and have a longer time horizon, simply continuing to pay the bills might be best. Over time, recovering house prices and declining mortgage balances likely will close some, if not all, of the equity gap. According to the Federal Reserve, while the housing bust wiped out $8 trillion in home equity, $1 trillion came back in 2009. The point here: time might be your best ally.

Another alternative: if Freddie Mac owns the loan, a family might be able to refinance up to 125 percent of the current property value. In other words, if a family's home equity has been completely wiped out and the mortgage balance is as much as 25 percent more than the home is worth, we can help.

What about families who need to move? We can help here, too. Freddie Mac has an array of solutions that help certain borrowers avoid the cost and stigma of foreclosure, such as short sales and deeds in lieu of foreclosure. And we continue to work on additional solutions that address would-be strategic defaulters while minimizing the impact on neighbors.

In the end, borrowers considering a strategic default should recognize the damaging impact their actions can have on others. While a personal financial strategy might argue for a strategic default, entire communities and future homebuyers can be harmed as a result. And that is why our broader social and policy interests will be best served by discouraging strategic defaults.


They sound desperate..


ronald said...

The RE model of the past 30 years is dead, so your comment that the government is desperate hits the spot. My guess is that what we are experiencing today is the new normal. The next 30 years might look very much like today with a few twist and turns:
GSE mortgage financing for 95% of mortgages,higher level of distress sales,GSE financing will be income driven,low down,low interest rates. GSE will own millions of housing units and be an active player in rental and leasing.

Effective Demand said...

The GSE's are absorbing the losses in the market and passing the losses onto the taxpayer. This is public policy and a less visible but just as big (if not bigger) of bailout of banks as TARP. With the government needing to "DO SOMETHING!" without actually knowing what to do this insanity will continue forever.

Anonymous said...

Current homeowners and RE investors are viewing the market in the rear view mirror not appreciating that the overall homeowners mortgage debt rose from 4 1/2 trillion to almost 11 trillion from 2002 to 2008 with a great deal of that debt in various types of cash out refi and additional 2nd and 3rd liens. It took almost 40 years to generate the first 4 trillion of debt! The equity in housing has been extracted what remains is but a shell of the former market that was dominated by move up buyers with good jobs and strong equity from prior homes for large down payments and remodeling. Markets change while we all wished it wasn't so the RE market may be in for a very long period that doesn't resemble prior data points and those that try and force the square peg in the round hole will learn the hard way.
Enjoy your blog always thoughtful posts and good quality data.
thanks for your effort!