Mortgage fright spreads like wildfire
Why homeowners who needn't worry are running scared
By Jack Guttentag, Monday, November 3, 2008.The mortgage world has suddenly become very frightening to many people who have no real reason to be frightened.
Their mortgages are in good standing, and they are not having any trouble meeting their payments, yet they are in distress -- in large part, because so many around them are in distress. Fear is contagious. The only antidote I know is good information.
One important thing that people suffering from mortgage fright often forget is that a mortgage loan is a contract between two parties, and it cannot be violated by either without the permission of the other.
If the loan is sold, the purchaser replaces the originating lender as the contracting party and is subject to the contract in the same way. If the servicing of the loan is sold, the servicer as the agent of the owner is required to abide by the terms of the contract, and the same holds if the loan is placed in a pool as collateral for a mortgage-backed security.
The first two letters below are from borrowers who do not have a problem with their current mortgages but are distressed about what might happen in the future to cause them a problem.
"Can whoever owns my mortgage demand immediate repayment of the balance? I know it doesn't make sense, but crazy things seem to be happening ..."
Mortgage contracts do not give the lender the right to demand immediate repayment. Balloon loans require repayment at the end of the balloon period, but that is stated in the contract. Fortunately, there are not too many balloon loans around.
Even if lenders had the legal right to demand immediate repayment, they wouldn't do it because it would only generate more foreclosures. For the same reason, borrowers with balloon loans in good standing who are unable to refinance anywhere else will find that their existing lender will prefer to refinance them than to foreclose.
"When the rate on my ARM adjusts next year, the new rate should be the one-year Treasury rate at the time, plus a margin of 2.5 percent. Last year, however, my lender replaced the Treasury rate on new loans with LIBOR. Because of the crisis, LIBOR is now 2.5 percent higher than Treasury. Can my lender switch my ARM to LIBOR when my rate is adjusted?"
No way, the rate is adjustable but not the index used to calculate it. Your ARM contract stipulates the index and its source, and the only circumstance in which a different index can be substituted is in the event the specified index is no longer available. The different Treasury indexes used by ARMs are compiled by the Federal Reserve and there is zero likelihood that they will disappear.
I wish I could answer the next letter with the same degree of certainty.
"We bought our house just last year with 100 percent financing, now it is worth $40,000 less than we owe. I don't know what to do. Do we keep making mortgage payments or do we stop? A friend has advised us to lock the door and send the key to the lender, but that doesn't sit very well with me. We've always met our obligations and have good credit. What do you advise?"
This letter is typical of many I have received from borrowers who are "upside down" in owing more than their houses are worth. I have a lot of trouble dealing with it because in good part it is a moral issue and my rabbinical credentials are weak.
My right-handed rabbi says that when you borrow money, you should pay it back if you can. During the many years when house prices were rising, he never once heard of a mortgage borrower offering to share the capital gain with the lender. There is no justification in forcing the lender to share the capital loss.
My left-handed rabbi rejoins that very few of the people who are upside down today enjoyed a capital gain on previous homes that they owned. Further, the borrower's major obligation is to his family, not to his lender. If the financial gain from letting the house go to foreclosure more than offsets the pain of having his credit trashed and having to find a new place to live, then that is what the borrower should do.
There is an economic dimension to this quandary. If those who are upside down could be assured that house prices had hit bottom and within a year or two they will be right-side up, there is little doubt that most would elect to stay the course. Unfortunately, no economist in good conscience can provide such assurance today.
Finally, there is a policy dimension. Upside-down borrowers would be encouraged to stay the course if they had some reason to believe that the government will help them get right-side up. Right now, the prospects for this are extremely murky, but don't write it off just yet.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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Submitted by Shannon Ziccardi on November 3, 2008 - 7:43am.
This affliction of "mortgage fright" is very real (at least in Southern California). Most disconcerting perhaps, is not the ability for a good borrower to continue paying, but instead, his level of motivation to continue doing so. Many neighborhoods have seen massive foreclosures where on a street of ten homes only one or two owners remain. These remaining owners are frightened because their home value has gone away.
One particular area of Riverside County along the I-15 freeway, recently dubbed "foreclosure alley" has seen an alarming amount of this fright. Many beautiful homes, less than five years old sit empty and abandoned with brown lawns and green swimming pools. What motivation could those who paid nearly $400,000 for their home have when the identical (bank owned) home sits across the street for sale at $189,000?
I try to avoid being the purveyor of doom and gloom as I believe the only thing keeping us from roaring back is consumer confidence. With the incentives being introduced for lenders to lend, at some point banks will need to give some relief to the "good guys" that stuck it out. Either way, it seems their fear is at least somewhat justified.
"A Quick Note"
www.aquicknote.net
Submitted by Wenceslao Fernandez Jr, BS, Realtor, CDPE on November 3, 2008 - 8:31am.
Great job, Jack. California, Nevada and Florida are among the hardest hit states for foreclosures.
However, I still recommend my "upset" would-be sellers to stay the course if they're able to.
I typically ask them if they have made a car purchase in the last 4-5 years. If the answer is yes, I then ask them how far along in their payments are they and if they realize that they are and will continue to be upside down on their loan of this car for typicially, about 4 out of a 5 year loan.
Why does it seem that it is OK to be upsidedown in a car loan when the car they are driving will NEVER appreciate (unless they hold it and keep it in mint condition for 25+ years)?
Why then is it difficult for them to stay put during an economic cycle rather than wait for the innevitable rise in property value and appreciation they will likely enjoy again?
For someone having no trouble making payments, being upsidedown is only a concept, while it is only on-paper that they are currently in this situation. They will not realize a loss unless they sell.
Like the dollar lost its value against the Euro, only to gain strength in a time when the Euro itself may now be in jeopardy, home values will in fact regain their value.
Just hang in there! This too shall pass!
Remember the elections are tomorrow (November 4th) and soon thereafter (remember Florida recounts?), we shall have this point of uncertainty behind us. Then comes January and the new president will be innaugurated.
According to Jim Cramer of CNBCs Mad Money in a show aired a few weeks ago, he predicts (and explained during that show), how he has come to the conclusion that the absolute bottom in real estate will be upon us come June, 2009.
If this prediction is right, we're at the tail end of this terrible period (we've been here for arguably some 2 years already, depending on when you call the crest of the market - accoring to Jim, it was in June, 2007). Therefore, in a few more months, we will begin to see property values accross the board rise (though it should be noted that there are markets where this is already evident, even today).
So...once again, if you are not in trouble and needing to sell, take several deep breaths, relax and position yourself to perhaps even buy real estate at rock bottom prices, then sell it in 36-60 months at a gain that may dwarf any perceived loss in your current home value.
www.MiamiRealEstateKing.com
Certified Distressed Property Expert
Miami-Dade County, Florida.
Submitted by Bonni Tierney on November 3, 2008 - 10:54am.
Shame on you for suggesting that people walk away from homes if it is no longer convenient to pay!!! Do you not get that you are contributing even more to the problems in the economy than the people who are being forclosed on? I have been in real estate for 32 years. We've had times where the property values doubled and some times where it was worth less. But the original homes that I did loans for $50,000 on 25 years ago are still worth $250,000 today.
There is no guarantee when you purchase a home that it will appreciate in value. It is not an investment. It is a home and the government rewards you for purchasing that home but giving you a sizeable write-off against taxable income.
Why should I, and everyone else, pay for you because it's no longer convenient to pay for your home? We lost equity during Reagan-nomics but the market bounded back three fold over the years. It will come back up again.
I consider the people who advocate for jingle mail and those who participate as criminals. When a buyer signs the note and trust deed it doesn't say you agree to pay as long as it's convenient. It says you will pay for the term of the loan. The bank doesn't get to come back and say, hey, your property doubled in value so share the equity with us. I think we should all remember that a person is only as good as their word. And when you don't keep your agreements your worth as a person is nil.
I am speaking to only those people who can afford their homes and choose to give them back because it's no longer convenient. We have enough people who legitimately cannot afford their payments or who got the wrong loan. But I am also an advocate for jailing those who committed fraud and received money for fraudulent loans.
Submitted by Walter Boomsma on November 3, 2008 - 1:17pm.
Great article... and the quoted letters are wonderful evidence of the fundamental problem... naive, uneducated buyers who for many reasons do not understand the implications of the mortgages they take and the documents they sign.
Unfortunately ingnorance is often thought to be it's own defense. We've bought the myth that regulations succeed in protecting the innocent and somehow believe there's something in the constitution establishing that the government is responsible for everything, including making sure people buy and keep houses they can't afford.