The answer is, no one knows, exactly. But they should be worst in 2008, improving thereafter.
The most vulnerable loans are subprime adjustable-rate loans issued with very low teaser rates at the peak of the housing bubble. Typically, those mortgages would reset after two years. Many of those borrowers, who had little-to-no equity in their houses, have just seen their rates reset to much higher levels, and have no hope of refinancing both because of the sharp contraction of credit for subprime borrowers, and because stagnant or falling home values mean that they have no equity to refinance with.
The refinancing problem is why we should see mortgage rates default rates rising even in the higher loan tiers. People in those mortgage classes are less likely to get into trouble because they have taken on wildly excessive financial obligations; when they default, it is almost always because someone has lost a job or the family has suffered some sort of similar financial setback. For the past few years, rising home values have given those people a financial cushion with which to ride out the storm, pushing default levels much lower than normal. That process is now reversing itself, though absent a recession, it's not clear whether the default rate in these classes will really rise higher than historical norms.
The biggest bulge of defaults should come next year, and by late 2008, the banks and the borrowers should know about most of the loans that are going to go bad. A recession would change this, of course--but unless it's deep, not by very much.
"The answer is, no one knows, exactly."
Maybe not, but I expect it is safe to predict subprime defaults will ultimately far exceed 15% making your previous post a bit disengenuous.
There is the possibility of lingering affects and positive feedback. Large numbers of defaults put large numbers of houses on the market simultaneously. That depresses value. From an investment perspective, the house becomes a liability. Default, though unnecessary, becomes a smart move.
That shouldn't be a big problem in older communities, but in newer developments, where many residents bought at about the same time, on roughly the same terms, it could hit like a flash flood.
Re: Default, though unnecessary, becomes a smart move.
Assume that your income stream is adequete to make the payments. Default destroys your credit rating and in some cases can sic the IRS on you for taxes due on the "loan forgiveness" (typically this occurs if the borrower abandons the property voluntarily before being forced out and the loan is then charged off outside of a bankruptcy process, the scenario you suggest). Where's the incentive to default? Even as an investor not an occupant of the house you're going to screw yourself over a lot worse than just paying those payments will. Additionally, if you're living in the house you have to find someplace else to live and go through the hassle and expense of moving.
' Default destroys your credit rating and in some cases can sic the IRS on you for taxes due on the "loan forgiveness" (typically this occurs if the borrower abandons the property voluntarily before being forced out and the loan is then charged off outside of a bankruptcy process, the scenario you suggest).'
First, empiracally, it is happening.
Second, you can assign a value to your credit rating. There are people with over a million dollars in loans outstanding on $400,000 houses. They are arguably better off ruining their credit, and (in the unlikely event it becomes necessary) paying taxes on the loan forgiveness than they are paying off hte mortgage. Instead of pouring their entire income stream into a money sink, they can invest their money in more worthwhile ventures. Long before their mortgage would have been paid off, their credit will be rehabilitated.
Now if a bank owned the mortgage, it would be in the bank's interest to prop up local property values by renegotiating terms with the potential defaulter as a matter of policy, asuming the bank has an interest in many properties in the neighborhood. But that's not usually the case nowadays.
Jonf, I would agree with you if the drop in prices werent so deep, my best friend is a nurse, and she bought 3 investment houses 2 in Riverside and 1 in San Diego, she is underwater for a total of at least 600 thousand dollars, if not more.
She is bleeding 2000 per month in rent vs mortgage.
What is the incentive to default?
Over half million dollars, thats a hell of an incentive.
She recieved a life insurance policy after her husband died from cancer, so she could keep making the payments.
In our area 45 percent of listings in the MLS are distressed/short sales or Reo's.
If your house drops 50 thousand or so, its not worth the hit to your credit, plus hassle of moving.
But here in socal, drops are around 150-200 grand for your average house, many around Irvine are double that loss.
How long to put 200 grand in your saving account?
Average person maybe 10 thousand a year?
20 years of saving?
My friend would need sixty years worth of penny pinching to match the loss on her homes.
Doing the right thing and protecting your credit rating only goes so far, even if you can afford to continue making the payments.
The previous post is illuminating - how many of the people who are "underwater" are underwater because they have the "investment" homes. Jsut as with any other investment, "past performance is not indicative of future gains". Can we craft a hypothetical bailout/landing-pad to inculde or avoid specifically these people...
And in a related but tangential note - what happens to the renters if/when the owners default?
Actually, I think there have been several articles out there on the effect of defaults/bankrupcies/whatever on renters.
Basically--they get very short notice that they have to get out of the location and find something else. So they get screwed as well by all of this.
Re: First, empiracally, it is happening.
Yes, but in most cases it involves investor-owned housing. Where the house is mortgager-occupied and assuming that the mortgager can afford the payments I suspect that this will be very rare.
Re: I would agree with you if the drop in prices werent so deep
What drop in prices? From what I have seen here in S Florida (one of the hot spots, both of the boom and now of the bust) housing prices are not dropping much at all: apart from a handful of sellers who must sell, most people simply dig in and refuse to sell for less than they think they ought to get for the house. Right on my street I've watched this happen, houses with For Sale signs that sit so for months, with no takers and also only minimal reductions in asking price (again, in cases where the homeowner is just trying to cash in, not where he urgently needs to sell, either because the house has become unaffordable or he has to rellocate for work or something like that). Finally the For Sale signs come down and the homeowners (most of whom bought years ago when prices were much lower) accept the fact they are not going to get rich quick off their house. It seems that many (most) people are just going to ride out the downturn, however long it lasts. And really, why should it matter what your house in worth in the abstract if you intend to live in it for the next ten years? What matters for the bottom line isn't its price today, but its price when you do want to sell in ten or twenty years. And since there's no information available on anything that far out in the future there's no point in even sweating it until the time draws near. Add in the fact that in boom markets like S Florida many long-term owners would make a very tidy profit even if they sold for half their asking price* and I don't see some mass rush to dump houses on the banks by people who are not in desperate straits already.
* Real example: in my neighborhood the houses were selling for c. $50,000 back in the early 90s, and now the asking price is in the upper 200ks or lower 300ks. Obviously a person who bought in 1992 is not losing his shirt on the deal if he "undersells" for 200K today-- though having been told that his house is worth 300K he is stubborn and won't sell for less.
Re: And in a related but tangential note - what happens to the renters if/when the owners default?
They may be required to move out (with loss of deposit, though they can probably get away with stiffing the mortgagee on the last month or two of rent), though sometimes mortgagees will make deals allowing them to continue renting as a way of keeping the house maintained and occupied. In those cases the eventual new owner from the foreclosure auction may find himself with the task of having to evict the renters before he can take possession.
Re: Basically--they get very short notice that they have to get out of the location and find something else.
I don't know about "short" notice. Foreclosures can take months, even more than a year. Eviction notices of course typically give ten days (though they can be fought a long time, as any landlord with a stubborn tenant knows) but it may take a long time before any such notice is served after the mortgage goes into default. As I noted above, it's not uncommon for a purchaser from a foreclosure auction to have to handle the eviction himself if the mortgager did not want to deal with it first.
Mr Jonf, I live here in Miami, actually Pembroke Pines.
We sold our 2 rentals in Orlando in 04 and 05.
We were very fortunate we sold when we did, I didnt really believe we had a bubble, but I am getting too old to be driving up there everytime a toilet plugs up.
My son ran into financial problems with his business, so we decided to sit on the proceeds from the sale, incase he needed help.
Thank goodness we didnt reinvest right away.
My former units are worth 40 percent less, due to foreclosures, and a builder auction 2 blocks away in September.
When I do decide to buy rentals again I will get them at 50 percent off their 2005 prices, and the sellers will thank me.
My home I bought in 1979, so even with a half off haircut I would still be up a decent amount after taking inflation into acount.
My home is paid off, I am not interested in selling, I will be fine.
But that doesnt mean the real estate market will be fine, these younger kids may have bought years ago like me, but where my generation saw debt as a burden, the younger folks see debt as income, lots and lots of heloc, all my son's friends drive fancy cars, all bought with the atm machine in their living room.
Also another problem is we are heading into a recession, which will afect peoples paycheck, so even if they were financialy prudent, they will be affected.
I have lived through many recessions in my time, how quickly we forget.
This will have a ripple effect, look at the local governments trying to pull their money out of the state employee investment funds, the funds were frozen leaving school districts scrambling to borrow money to pay the teachers, and this is only begining.
Try to get those funds to finance any more funny money loans after theyve lost billions.
Without funny money, we will go a lot lot lower.
When I was looking to buy here there was 11,000 residences for sale on realtor.com, end of 05.
I just went tonight to see what the numbers are and am shocked, sfh 12,700, condos 23,163, mfh 1,302 for a grand total of 37,165.
And even worse telling are the people who are amatures, trying to find tenents to avoid losing their properties, in 05 my competition had 1500 houses listed, now it is 9,773.
Go check out the rental numbers for LA, 1,051 listed, thats a sign of the stress that wont show itself for another 24 months or so.
I have worked in this market as both a seller and a buyer, and prices have most definativly dropped, maybe not on your block, but the market is much larger than yours, or my immediate vicinity.
Some (many?) of the defaults will come from small companies which were setup entirely for the purpose of investing in property. The companies will not wait until the mortgage rates adjust, they will cease to make mortgage payments as soon as it becomes clear that property values have fallen to the point where it is no longer possible to make a profit.