The rising trend of 'strategic defaults'

Given the economic problems associated with foreclosures, it's hard to imagine that taxpayers will want to continue propping up Fannie Mae, Freddie Mac and FHA in the wake of the rising tide of 'strategic defaults.' Sure, it might be an objective decision for individuals but collectively it'll be interesting to see the impact in our now ethnically challenged society. From Kenneth Harney's "Nation's Housing" column in the L.A. Times:

Research using a massive sample of 24 million individual credit files has found that homeowners with high scores when they apply for a loan are 50% more likely to "strategically default" -- abruptly and intentionally pull the plug and abandon the mortgage -- compared with lower-scoring borrowers...

Among researchers' findings are these eye-openers:

* The number of strategic defaults is far beyond most industry estimates -- 588,000 nationwide during 2008, more than double the total in 2007. They represented 18% of all serious delinquencies that extended for more than 60 days in last year's fourth quarter.

* Strategic defaulters often go straight from perfect payment histories to no mortgage payments at all. This is in stark contrast with most financially distressed borrowers, who try to keep paying on their mortgage even after they've fallen behind on other accounts.

* Strategic defaults are heavily concentrated in negative-equity markets where home values zoomed during the boom and have cratered since 2006. In California last year, the number of strategic defaults was 68 times higher than it was in 2005. In Florida it was 46 times higher. In most other parts of the country, defaults were about nine times higher in 2008 than in 2005.

* Two-thirds of strategic defaulters have only one mortgage -- the one they're walking away from on their primary homes. Individuals who have mortgages on multiple houses also have a higher likelihood of strategic default, but researchers believe that many of these walkaways are from investment properties or second homes.

* Homeowners with large mortgage balances generally are more likely to pull the plug than those with lower balances. Similarly, people with credit ratings in the two highest categories measured by VantageScore -- a joint scoring venture created by Experian and the two other national credit bureaus, Equifax and TransUnion -- are far more likely to default strategically than people in lower score categories.

* People who default strategically and lose their houses appear to understand the consequences of what they're doing. Piyush Tantia, an Oliver Wyman partner and a principal researcher on the study, said strategic defaulters "are clearly sophisticated," based on the patterns of selective payments observable in their credit files. For example, they tend not to default on home equity lines of credit until after they bail out on their main mortgages, sometimes to draw down more cash on the equity line.

Strategic defaulters may know that their credit scores will be severely depressed by their mortgage abandonment, Tantia said, but they appear to look at it as a business decision: "Well, I'm $200,000 in the hole on my house, and yes, I'll damage my credit," he said of defaulters. But they see it as the most practical solution under the circumstances.

The Experian-Wyman study does not try to explore the ethical or legal aspects of mortgage walkaways. But it does suggest that lenders and loan servicers take steps to screen and identify strategic defaulters in advance and possibly avoid offering them loan modifications, since they'll probably just re-default on them anyway.

Mortgage problems and their impact on credit scores

Wondering just how much mortgage defaults, short sales, foreclosures and bankruptcies impact credit scores? Syndicated columnist Kenneth Harney takes on the issue in his latest issue of the Nation's Housing column in the L.A. Times:

A scoring company created by the three national credit bureaus -- Equifax, Experian and TransUnion -- has some eye-opening numbers. VantageScore Solutions, whose risk-prediction scores are now being used by some of the largest mortgage companies and banks, has found that the way consumers handle their mortgage problems can have profound effects on their credit scores.

For example, loan modifications that roll late payments and penalties into the principal debt owed on the house can actually increase borrowers' scores modestly. Refinancings of underwater, negative-equity mortgages -- which the Obama administration's Making Home Affordable program offers through government-controlled Fannie Mae and Freddie Mac -- may have little or no negative effect on scores, even though the homeowners might have been tottering on the edge of serious delinquency before refinancing.

The Vantage credit score, the primary competitor to the long-dominant FICO credit score, rates borrowers on a scale range of 501 (subprime, the highest risk) to 990 (super-prime, the lowest risk). Unlike Fair Isaac Corp.'s FICO scoring system, whose scores can vary by 50 to 100 points based on which bureau supplied the underlying credit data, Vantage scores are about the same for each consumer.

When homeowners negotiate a short sale with lenders, they sometimes assume that there will be relatively little effect on their scores. After all, the loan was successfully paid off, there was no foreclosure, and the lender voluntarily agreed to accept a lower balance than was owed.

But according to VantageScore researchers, short sales can trigger big drops in credit scores. Sarah Davies, senior vice president of analytics, said a homeowner with an excellent score of 862 might plummet 120 to 130 points after a short sale.

Although it's true the lender may lose less money through a short sale compared with a foreclosure, "it's still a derogatory event," Davies said. The full debt was not repaid and the lender lost money.

What happens when borrowers walk away from their mortgage debts altogether -- the so-called strategic defaults that have become commonplace in some large markets such as in California? They should expect 140- to 150-point hits to their scores, plus negative marks on their credit bureau files for as long as seven years.

People who file for bankruptcy protection covering all their debts (mortgage, credit cards, auto loans, etc.) will get hit with an average 355- to 365-point drop in their scores. Bankruptcies remain on borrowers' credit bureau files for 10 years...

But the bottom-line good news about scores is that homeowners facing financial stress can experience minimal dings to their credit if they contact their loan servicer or lender early in the game -- when they first discover that they may have trouble making their monthly payments -- and take the first steps toward a loan modification or refinancing.

"Start that conversation early," said Barrett Burns, a former lender and now chief executive of VantageScore. If you wait and fall several payments behind before seeking a modification, "you can lose 240 points on your score" and damage your ability to obtain credit for years.

Translation: don't be a flake.

Mortgage industry throws more hurdles onto borrowers

Although home prices continue to fall and mortgage rates are historically low, nervous lenders continue to pile on new fees and requirements for borrowers hoping to jump back into the market. From the "Nation's Housing" column in the L.A. Times:

Take Fannie Mae's and Freddie Mac's add-on fees for loans purchased after April 1. In some cases, applicants are being hit with extra fees of 3% to 5% because of the type of property they want to buy or refinance, their credit scores or the size of their down payment.

Some major lenders who sell loans to Fannie and Freddie are going further -- tightening underwriting rules beyond what either corporation requires...

Fannie Mae now has a mandatory fee of three-quarters of a percentage point on all condominium loans, no matter how high the applicant's credit score...

On top of these extra fees, borrowers are now starting to get hit with two sets of cost-raising appraisal rule changes. Fannie and Freddie have begun requiring all appraisers to complete an extra "market condition" report that includes detailed statistical analyses of local sales and pricing trends -- above and beyond the regular appraisal data. Many appraisers are charging an extra $45 to $50 for the time required to complete the form. Home buyers and refinancers can expect to pay the higher fees.

On top of that, beginning May 1, Fannie and Freddie are refusing to fund loans with appraisals that do not follow a set of new rules known as the Home Valuation Code of Conduct. Among the procedural changes: Mortgage brokers no longer can order appraisals directly, but instead must allow lenders or investors to use third-party "appraisal management companies" to assign the job to appraisers in their networks.

How does that affect the consumer? Consider the notification one Connecticut brokerage firm recently received from a major lending partner: Starting April 15, all good faith estimates provided to applicants must indicate a flat $455 charge for appraisals arranged through the appraisal management company. The broker previously charged $325. Consumers will now have to pay the appraisal fee upfront -- before any inspection or valuation is completed -- using a credit card, debit card or electronic fund transfer.

What happens if the appraisal comes in low and the applicants can't qualify for the refi or purchase program they sought? Tough luck: They'll have just two choices: Pay another $455 for a second appraisal -- with no assurance that it will solve the problem -- or cancel the application...

Click here for entire column.

"Broker price opinions" depressing property values

While recently updating the real estate section for a San Diego economic conference in April, I came across an interesting tidbit: when retail space is located in mixed-use (residential plus retail) developments, it's been reporting higher vacancy rates and lower rents versus traditional retail centers. Why is this? Well, for starters, mixed-use projects are very complex, especially when it comes to parking. Moreover, if the stores depend on new housing units for their traffic, then weakness in housing will undoubtedly have an impact.

I mention this because when I was writing market studies for mixed-use projects, builders would almost always order an objective analysis for the residential portion only, preferring to turn to commercial brokers for an analysis of the retail space's ability to absorb space and achieve specific rental prices. But c'mon, seriously, how silly is that? Because although I'm sure there are plenty of commercial brokers who will provide an objective opinion of a specific project, how do you know if they're only telling the client good news to get the listing? If they're crossing their hearts?

If the residential sector is any example, asking a broker to provide an opinion of value instead of ordering a full-scale appraisal or a traditional market study is simply courting disaster. And these days, in an effort to get more short-sale and foreclosure listings, some agents will, for a variety of reasons, low-ball values. And some people think that's further escalating pricing declines in neighborhoods already filled with distressed properties. From Kenneth Harney's column in the L.A. Times:

Unlike standard property valuations performed by licensed appraisers -- which can run to hundreds of dollars -- BPOs often cost $50 and are performed by real estate agents who may have minimal or no appraisal training and are subject to no regulatory oversight. Realty agents defend BPOs, contending that their extensive knowledge of local market trends equips them to render accurate estimates.

BPOs have become a booming business as foreclosures and short sales have risen sharply. When banks that own foreclosed houses need to put values on them for resale, increasingly they order BPOs that can be delivered quickly at rock-bottom fees.

Short sales -- in which a lender agrees to take less than the principal amount owed by a delinquent owner, provided that the property is sold to a new buyer -- also frequently entail use of BPOs...

One problem is that selling BPOs to value houses violates the law in 23 states, according to appraisal industry leaders. In other states, BPOs may not be prohibited, but critics say they may be far off the mark in accuracy -- typically coming in below appraised values. That's partly because agents who perform the BPOs may set the value extra low to ensure quicker sales.

When BPO-valued houses are listed at fire-sale prices, they exert a downward pull on the values of other houses in the neighborhood because, under lending industry underwriting guidelines, appraisers must consider recent listing prices as well as sale prices...

Gary Crabtree, chief executive of Affiliated Appraisers in Bakersfield, says his company's research "shows very clearly" that BPOs frequently understate actual market values by as much as tens of thousands of dollars.

Why would agents lowball their BPO valuations? Crabtree contends that there are inherent conflicts of interest: "They want to sell the property fast" to make bank asset managers "look like heroes" to their bosses. They may also want additional BPO and property listing assignments from those same bank managers, yielding them commission dollars.

Many of the properties are snapped up by investors at the depressed prices driven by BPO valuations. Those sales then become "comparables" for appraisers, "which simply intensifies the downward spiral" in local property values, Crabtree said.

Are we learning lessons in this country from the past about people who will do anything for a dollar? It sure doesn't look like it.

Loan work-outs now available before missing mortgage payments

Up until this point in the mortgage crisis, borrowers had to be behind on their payments before lenders would even consider re-working a loan. Now, however, more lenders are allowing 'early workouts' when a wage earner loses a job, thus imperiling a mortgage soon down the road. From Kenneth Harney's column via the L.A. Times:

Here's some good news for homeowners facing tough financial times: You no longer have to miss two to three months of payments before your mortgage firm can modify your unaffordable loan terms.

Fannie Mae, the mortgage giant with an estimated 18 million home loans in its portfolio or in mortgage bond pools it guarantees, now will allow borrowers who face financial difficulties to request "early workout" loan alterations, even if they've never been late.

Fannie's policy change has the potential to help thousands of people who are losing jobs or facing layoffs as the recession crunches onward. Most lenders and loan servicers traditionally have declined to intervene in mortgage problems until borrowers are 60 to 90 days late. So-called loss mitigation staffs may then try to work out solutions through techniques such as rescheduling back payments or extending the loan term.

Under Fannie Mae's revised approach, servicers of the company's loans will be required to inform borrowers that if they are "reasonably" certain that changes in their income will cause them to miss mortgage payments, they might qualify for an advance loan modification -- before they fall behind.

Borrowers who qualify will enter into a trial period of reduced payments, usually for four months. If they make payments on time during the trial, the modified mortgage terms could be made permanent.

Click here for full story.