The Foreclosure Game
It’s getting ugly out there. No matter where you live in the United States mortgage defaults are up, as are foreclosures. Though everyone looks to the incoming Obama Administration to do something miraculous for homeowners, the stats don’t look good. In many markets falling home valuations have erased owner equity completely. People owe more than their house is presently worth and are paying more to live in that depreciating hovel than it would cost to rent something perfectly comparable down the street.
No wonder foreclosures are up.
But the truth is that your bank or mortgage company would actually far rather NOT foreclose, because foreclosure is a losing game for the bank.
The entire point of down payments on mortgages is enabling foreclosures. It always has been. But that doesn’t mean foreclosures are in the general interest of the lender. The ideal for lenders, remember, is to keep us owing as much as possible on our homes for as long as possible, so down payments just cut into their action. In an ideal environment the lenders would rather lend 100 percent of the house value. And as long as home values were consistently rising faster than inflation the banks could get away with that, because they actually MADE MONEY on foreclosures.
Here’s how foreclosures used to work. It takes a year and several thousand dollars worth of legal work to actually foreclose on a home, during which time the bank or lender is also deprived of revenue from the mortgage because we aren’t making payments, remember. But as long as home values were going up AND THE BANK COULD ACTUALLY SELL FOR THAT HIGHER AMOUNT it didn’t really matter. That’s because the increase in home value during the foreclosure time frame usually more than made up for the legal costs and lost revenue, even for houses originally bought with no money down.
This is yet another reason why the housing bubble got so big, because the lenders saw themselves as having literally no risk. THEY WANTED US TO DEFAULT. That is until housing prices started going south.
The current situation is far worse, however. The point of having a traditional 20 percent down payment was that the difference between the principle on the loan and the actual home value (that difference being the down payment) was supposed to more than cover the expenses of any foreclosure, even in a non-boom market. So traditionally while the lender didn’t WANT to foreclose, they also weren’t afraid to do so, because the down payment covered their inherent risk.
But no more. We’re in a housing Depression. With our houses leveraged as much as possible and selling prices down by 30+ percent in many markets, there is no longer that equity cushion to protect the bank. Where banks used to easily get 80 cents on the dollar or more through foreclosures, their current yield is closer to 50 cents on the dollar. Banks have a lot less incentive to foreclose than they did a year or more ago. Foreclosures are a losing business for banks and banks HATE to lose money.
The preferred alternative to foreclosure these days is loan modification. Surprisingly, banks tend to LOVE loan modifications. This is for two reasons; 1) they aren’t losing money on a foreclosure, and; 2) loan modifications as they are presently being done are actually profit centers for most lenders. Though we homeowners appear to pay less for our homes under modification plans, the banks actually tend to make MORE profit on the revised deals.
The point of loan modifications is to get your monthly payment down to something you can actually pay. The point quite specifically ISN’T to help you actually own your home. So the typical loan restructuring spreads out repayment, converting your 30-year mortgage into a 40-year mortgage, making the next 10 years of that loan interest-only. Your payment drops by a few hundred dollars per month and you feel some relief. But if you calculate the extra interest you’ll be paying over the life of the loan that savings is very expensive, benefiting only the bank.
Still, we tend to accept the modified terms because the payments are lower and it is only until we can refinance, right? Wrong. Underwater loans CAN’T be refinanced unless we come up with a big down payment we don’t have. So instead of being stuck with this loan for 2-3 years, we could be stuck with it for 40, or more likely the average 10 years we’ll own the house.
Extending the shelf life of the average mortgage from the current three years to 10 is a huge boon to the banks because they don’t have to spend three times as much marketing money to support the same level of homeowner debt over that time frame. They don’t have to sell the loan three times over, instead simply allowing us to stay in the house we couldn’t afford in the first place and really still can’t afford.
Lucky us.
Another reason foreclosures are terrible for banks right now is that many of the worst performing loans put down far less than 20%, so there was even less equity for the bank to recoup when balancing that against 30% or 40% depreciation.
Also, color me pessimistic, but I can’t help but think that one of the main motivations for banks doing loan mod’s is to kick the can down the road a few years. Faced with a deluge, the banks want to spread the foreclosures out through time, but I have no doubt they’ll be a lot more interested in foreclosure when the market recovers a bit.
If they get some profitable cash flow in the meantime, all the better for them, right?
Another problem with load modification is that it doesn’t help the overall housing market because without a sale, the “true value” of the home can’t be established. That’s the upside to foreclosures. Eventually a realistic home value price floor will be established.
I thought I read somewhere that somewhere in the tangle of middlemen involved in packaging and repackaging and cuisinarting all of those sub-prime mortgages there is someone who actually makes money off of some fees or penalties or something if the buyer falls into arrears, or if the house goes into forclosure, and that a lot of loan restructuring is being blocked by them.