Lender concern about strategic defaults has been increasing as more borrowers who can afford to make their payments are making a “business decision” to walk away rather than continuing to make payments on homes that are worth less than their outstanding mortgage. Now, this trend has no taken a new twist as borrowers who are planning to default seek to secure a mortgage on a new home first --a strategy known as “buy and bail.”
“Its an attempt to escape payments on a home whose value may never recover while securing new property, often at a lower price with a more affordable loan,” a Bloomberg News” article describing the practice explained. Industry analysts estimate that between 12 percent and 20 percent of defaults in the first half of this year were strategic. There are no statistics on the number of defaults involving borrowers who “bought and bailed” or tried to do so, but mortgage brokers and real estate brokers quoted in the Bloomberg article cited several examples of the trend.
Fannie Mae and Freddie Mac have both adopted measures designed to curb the practice, by excluding rental income from an existing home in the calculation of a borrowers’ eligibility for a loan on another residence, and requiring reserves equal to the mortgage payments on both homes. Industry reports indicate that these measures have curbed buy-and-bail ploys, but not entirely. “Savvy people can always find a way to circumvent these policies,” Meg Burns, an official with the Federal Housing Finance Agency, told Bloomberg.
While housing and law enforcement agencies are trying to combat voluntary strategic defaults, foreclosures resulting from involuntary defaults continue to rise. Foreclosure filings increased in more than three-quarters of U.S. metropolitan areas, according to RealtyTrac, with the hardest-hit market (Las Vegas) tabulating 1 filing for every 15 households.
Foreclosures have increased most steeply among “prime” borrowers, including those holding jumbo loans, who are also the most likely to have sufficient assets to try the “buy and bail” ploy. Foreclosures on prime mortgages increased by more than 400 percent in the past two years, according to Lender Processing Services, while foreclosures on jumbo loans have increased by nearly 600 percent.
A somewhat more encouraging report from Experian and Oliver Wyman indicates that strategic defaults may have peaked in the fourth quarter of 2008, with statistics for the second quarter of last year possibly representing “the first signs of a break in the clouds,” according to the report. A more detailed analysis of recent delinquency and default data is needed “to validate this [conclusion],” Peter Carroll, a partner at Oliver Wyman, indicated.
The Wyman-Experian report also noted an important distinction between strategic defaulters and “cash flow managers,” who have fallen behind but still make periodic mortgage payments. “Cash-flow managers would be better candidates for loan modification programs than strategic defaulters,” Charles Chung, general manager of decision sciences for Experian, told National Mortgge Professional, because they apparently have the resources to cover their non-mortgage obligations and have indicated a desire to resolve their delinquency. “A loan modification that makes their mortgage payments more affordable is likely to be very effective,” Chung said.
HOUSING ASSISTANCE
In the face of persistent unemployment and still rising foreclosure rates, the Obama Administration is ratcheting up its efforts to help struggling homeowners hang on to their homes.
The Department of Housing and Urban Development (HUD) is offering non-interest loans of up to $50,000 to help borrowers in hard-hit areas make their housing payments for as long as two years. The $1 billion program targets borrowers who have experienced “a substantial reduction” in their income because of involuntary unemployment, underemployment or medical problems, a HUD press release explained. The new “Emergency Homeowner Loan Program” will supplement an existing program through which the Treasury Department is providing assistance $2 billion in aid to 17 states with unemployment rates above the national average, to help finance their foreclosure prevention efforts.
These initiatives “will ultimately impact a broad group of struggling borrowers across the country and in doing so, further contribute to the administration’s efforts to stabilize housing markets and communities,” Bill Apgar, HUD’s senior adviser for mortgage finance, said in the press statement.
Separately, Fannie Mae announced a new program offering relief for borrowers suffering “unique hardships,” allowing them to skip up to six months of mortgage payments. The aid is limited to borrowers whose financial problems result from the injury of death of a spouse serving in the military or from problems related to the installation of drywall imported from China, which has caused structural damage to homes and a range of medical ailments for many occupants.
OVERDRAFT PENALTY
A federal district court judge in California has ordered Wells Fargo to pay more than $200 million to compensate consumers for overdraft practices the court found to be abusive and improper. “The bank’s dominant, indeed sole motive was to maximize the number of overdrafts and squeeze as much as possible” from overdrawn consumers, Judge William Alsup ruled, finding that the bank had improperly processed transactions in order of size, largest to smallest, rather than in the order in which they were received.
Wells Fargo argued that customers appreciated having their larger transactions – mortgages, rent and automobile payments – covered first, to avoid serious problems that could result if those payments were rejected. But Judge Alsup wasn’t convinced.
“The supposed net benefit of high-to-low re-sequencing is entirely speculative,” he wrote, but “its bone-crushing multiplication of additional overdraft penalties is categorically assured.”
A federal law that took effect this month will require financial institutions to obtain “opt-in” permission from consumers before providing overdraft protection – a service most have offered automatically, without the permission of customers and often without their knowledge.
Overdraft charges have generated millions of dollars in fees for financial institutions, which most are not relinquishing without something of a fight. Press reports indicate that many banks have inundated customers with “urgent” messages warning that they could lose the overdraft protection they have enjoyed and advising them to opt-in so they can retain this service.
These marketing campaigns appear to be having some effect. A recent survey by The Nielsen Co. found that 26 percent of consumers intend to opt-in, while 39 percent say they are still undecided.
Consumer advocates are trying to counter these messages with warnings of their own about the high cost of overdraft fees and about the availability of less expensive alternatives, such as linking checking accounts to savings accounts or liens of credit.
“This whole monster has kept growing and growing since we first ran across it,” Jean Ann Fox, a spokesman for the Consumer Federation of America, said of overdraft programs. “It’s not going away,” she told MSNBC. “There’s billions of dollars on the table.”
CREDIT SCORING SCORECARD
There’s good news and bad news in recent reports on credit score trends. The bad news is for consumers-- their average scores are declining nationally, with more than 25 percent (43.4 million consumers) now below 549, making it difficult if not impossible for them to obtain credit.
The good news is for Fannie Mae and Freddie Mac, the secondary mortgage market giants struggling under the weight of the bad loans they have purchased. The average FICO score on loans in their portfolios is now 750, up from 715 for loans purchased in 2006 and 2007 -- the years that produced the lion’s share of the losses that pushed the companies into federal receivership.
The higher scores for Fannie and Freddie reflect the stricter underwriting standards they have adopted-- clearly good for them, but, again, not so good for prospective mortgage borrowers, an increasing number of whom aren’t able to qualify for loans.
But there is some good news for consumers, too. While their average FICO scores have declined, the number of consumers with top scores of 800 or more has increased, now representing 17.9 percent of the total compared with the historical average of 13 percent, according to a recent analysis by FICO Inc.
The FICO report also found a small but potentially significant decline in the number of people with “moderate” scores in the 650-699 range. It is borrowers in this middle range who are feeling the brunt of tighter lending standards, according to a recent Associated Press article, highlighting what it described as a “serious drawback” in the reliance on credit scores: Lenders can’t distinguish between the borrower whose default resulted from irresponsible behavior and the one who defaulted because of a job loss. Both would be rejected based on their credit scores, the article noted, even though the unemployed borrower, who has obtained a new job, now represent a much better credit risk.
Some industry executives say risk aversion is making lenders focus too much on credit scores and not enough on individual circumstances that distinguish one borrower from another. “We absolutely swung way too far in the liberal lending,” one mortgage broker quoted in the AP article acknowledged. “But did we have to swing so bar back the other way?”
HOME REDUCTIONS
Expanding waist lines have made “super-sized” portions less appealing to some consumers; financial restraints and energy concerns have led them to rethink the mega-home preferences that prevailed before the economy and the housing market imploded.
After increasing steadily for nearly 30 years, the average size of newly-constructed single-family homes declined in 2009, slicing about 100 sq. ft. off the 2007 average 2,521 sq. feet, according to a recent Census Bureau report.
The last recession, in the early 1980s also triggered a decline in home sizes, quickly reversed when the economy recovered. “But this time, the decline is related to other phenomena, such as the increased [proportion] of first-time buyers, a desire to keep energy-costs down, smaller amounts of equity in existing homes to roll into the next one, tighter credit standards, and less focus on the investment component of buying a home,” David Crowe, chief economist for the National Association of Home Builders, suggests. “And many of these tendencies are likely to persist and continue affecting the new home market for an extended period,” he predicts.
New homes completed last year had fewer bedrooms and fewer bathrooms than homes completed in 2009, reversing a 20-year trend that had added rooms as well as square footage to homes. The proportion of homes with 4 bedrooms declined from a peak of 39 percent in 205 to 34 percent last year, while the proportion with 3 bedrooms fell from 53 percent to 49 percent during that period. Bathrooms followed the same trajectory. The proportion with 3 baths fell to 24 percent from 28 percent in 2007 and 2008, while the percentage with 2-1/2 baths has remained flat, at 31 percent. The percentage with 2 bathrooms, meanwhile, increased from 35 percent to 37 percent, according to the Census data.
Builders are also constructing fewer two-story homes. Starting in 1973, the number of multi-story homes began to increase, rising from 23 present to a high of 57 percent in, while the proportion f single-family homes, which represented 67 percent of the total in 1973, declined, reaching a low of 43 percent in 206 and 200. Since 2006, that trend has reversed, however, with the proportion of single-family homes increasing to 47 percent last year, while the share with two or more stories declined to 53 percent.
The Census Bureau’s annual report on the characteristics of new homes also identified some interesting regional differences in, among other areas, air conditioning, single-family homes and the selection of exterior wall material. According to the report:
99 percent of the homes in the South and 90 percent in the West had air conditioning, compared with 69 percent in the West and 75 percent in the Northeast.
Nationwide, only 17 percent of new single-family homes completed last year had three-car garages, with that regional distribution ranging from 11 percent in the Northeast and South, to 30 percent in the Midwest and 26 percent in the West;
Nationwide, 34 percent of new homes had vinyl siding, but that was the choice for 74 percent of new homes in the Northeast and 62 percent in the Midwest. In the South, only 28 percent of new homes had vinyl siding while 40 percent had brick, the choice for only 11 percent of homes in the Midwest.
