Reno Real Estate Logic

 It’s getting pretty obvious now that the Law Schools are writing papers on the “Social Management” of how the banking systems are still controlling the decisions people are making about maintaining massive mortgage debt vs bailing on the debt. This is a very insightful article  and paper written by Brent T. White. Lots to think about.

If you decide to short sale after you read this doo-sey do call me.       Michelle Plevel

This is a very good research paper from the University of Arizona entitled “Underwater and Not Walking Away:  Shame, Fear and the Social Management of the Housing Crisis.  Warning the .pdf is 54 pages long, but worth reading in its entirety. The paper’s assertion is that there is a huge asymmetry between lenders and borrows in terms of financial, moral, and social responsibility when it comes to home mortgages.    The playing field is not level and biased towards lenders which keeps people tied to paying mortgages on properties which are so severely underwater that it will take 18-20 years or more to recover, yet people with a solid financial understanding  will continue to pay despite the financial  logic of walking away. ( I am in that boat, I suspect many others here are also) The paper’s conclusion is it is time to put to rest the assumption that a borrower who exercises the option to default is somehow immoral or irresponsible. To the contrary, walking away may be the most financially responsible choice if it allows one to meet one’s unsecured credit obligations or provide for the future economic stability of one’s family.Individuals should not be artificially discouraged on the basis of “morality” from making financially prudent decisions, particularly when the party on the other side is amorally operating according to market norms and could have acted to protect itself by following prudent underwriting practices.The current housing bust should be viewed for what it is: a failure in government policies to promote housing in conjunction with loose monetary policies at the Fed – not a moral failure on the part of American homeowners. That being the case, it is time to take morality out of the picture and search for an equitable solution to the negative equity problem.  Other interesting tidbits: As of June 2009, more than 32% of all mortgaged properties in the U.S. were “underwater,” meaning that the homeowner owed more on their mortgage than their home was worth. This percentage is expected to increase to 48% by the first quarter of 2011, by which time housing prices in the largest 100 metropolitan areas are predicted to have dropped 42% from their peak. The national numbers hide the full extent of the problem, however, as the percentage of underwater mortgages is much higher in the regions suffering the worst price declines. For example, as of June 30, 2009, 66 percent of mortgage borrowers were already underwater in Nevada.  47% percent of homeowners in Nevada had negative equity exceeding 25% of their home’s value. The Financial Logic of Walking Away Before examining why more underwater homeowners are not strategically defaulting, it might be helpful to explore why they should. A textbook premise of economics is that the value of a home, even an owner occupied one, is “the current value of the rent payments that could be earned from renting the property at In other words, when the net cost of buying a home exceeds the net cost of renting, one is better off renting. The equation is not as simple, however, as comparing total mortgage payments to rent payments because home ownership carries certain benefits including tax breaks and the potential for appreciation. Additionally, assuming a non-depreciating market, the portion of the mortgage payment that goes to principle rather than interest will eventually inure to the homeowner at the time of sale. On the flip side, homeownership carries significant costs that renting does not, including maintenance, homeowner’s insurance and substantial transaction costs upon selling In calculating whether to buy or rent, a potential homebuyer should compare the net cost of owning to the net cost of renting a similar home over the expected period of occupancy. The costs of owning include the interest-only portion of the loan payment, property taxes, maintenance, homeowners insurance, and transaction costs upon selling, minus the expected appreciation and cumulative tax savings over the planned period of ownership. As a rule of thumb, a potential homebuyer is generally better off renting when the home price exceeds 15 or 16 times the annual rent for comparable homes The calculation for a rational homeowner in deciding whether to strategically default on a home mortgage is similar to that for buying in that base calculation is still the cost of renting verses the cost of continuing to own. However, the underwater homeowner has additional considerations, including existing negative equity on the one hand and the costs of foreclosure on the other.  Even leaving aside these foreclosure costs, the calculation as to whether one is financially better off defaulting requires one to consider several additional variables for which one may not have good information. These variables include a reasonable estimate of the current value of one’s home, the cost to rent a similar home, an idea of how long one intends to stay in the home, and an estimate of the average appreciation or depreciation one’s home is likely to experience over that period of time. While each variable requires some guessing, there is a wealth of information available to assist homeowners in making rational estimates – should they endeavor to do so With these estimates in hand, a homeowner also needs to know the current principle balance on their mortgage(s), the monthly interest-only portion of the mortgage(s), monthly mortgage insurance, if any, the amount monthly taxes, insurance, and homeowners association dues, if any, and their annual tax savings from owning verses renting. A rational homeowner can then make relatively simple calculations as to how much money they would save or lose by walking away, both on a monthly basis and over time. They can also predict out how long it will take to recover their equity Homeowners should be walking away in droves. But they aren’t. And it’s not because the financial costs of foreclosure outweigh the benefits. To be sure, foreclosure comes with costs, including a significant negative impact on one’s credit rating.43 But assuming one had otherwise good credit, and continues to meet other credit obligations, one can have a good credit rating again – meaning above 660 – within two years after a foreclosure  Additionally, in as little as three years, one can qualify for a federally-insured FHA loan to purchase another home While the actual financial cost of having a poor credit score for a few years may be hard to quantify, it is not likely to be significant for most individuals – especially not when compared to the savings from walking away from a seriously underwater mortgage. While a good credit score might save an average person ten of thousands of dollars over the course of a lifetime, a few years of poor credit shouldn’t cost more than few thousand dollars. Moreover, one who plans to strategically default can take steps to minimize even this marginal cost. For example, one could purchase a new vehicle, secure a new home to rent, or even purchase a new house before beginning the process of defaulting on one’s mortgage. Most individuals should be able to plan in advance for a few years of limited credit There are, of course, costs to foreclosure other than temporarily poor credit. These include moving costs and possible transportation costs if one is required to live further from work or school. But again, these costs are minimal when compared to the savings of shedding a home that is hundreds of thousands of dollars underwater. The most significant financial risk from a foreclosure is the risk of a deficiency judgment or, in the alternative, tax liability for the unsatisfied portion of one’s loan upon foreclosure. But even these potential costs are significantly less than one might expect. First, a number of states – including many with the biggest declines in home values – are non-recourse states, meaning that lenders may not pursue homeowners for a deficiency judgment if the home was their primary residence. Second, even in recourse states, lenders rarely pursue borrowers for deficiency judgments unless they have special reason to suspect  the borrower has means to pay it. This is particularly true to the extent that the home is in a state where lenders are overwhelmed with foreclosures.47 Third, tax regulations have recently changed to waive taxes on the unpaid portion of a mortgage upon foreclosure, which was previously classified as income to the borrower if the lender reported it as such.