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Musing on Culture: Is There Still a Stigma to Foreclosure?

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SHAME! SHAME ON THE FORECLOSED!

Back in the dark, dark days of the Bubble (2008-2011), I remember thinking a lot about, and talking about, strategic default. Here’s a sample from the tail-end of 2010:

What got me wondering is whether that commercial and others like it, which constantly denigrate banks, call mortgages illegal and immoral, and talk about how you can transform debt into wealth and all other sorts of nonsense are having an effect nonetheless on the real estate market. Wall Street Journal the other day profiled a homeowner who walked away from an underwater mortgage, despite being able to pay. I just wonder if there’s a connection at all between these guys who are hawking whatever debt consolidation or credit counseling services they’re offering using fairly… ah… hyperbolic language and the increasing social acceptance of “strategic defaults”.

Here we are in 2016, and the market is booming across the board. The single biggest complaint in the industry is that there aren’t more homes to sell. Prices are up, into the stratosphere in some markets (San Francisco, New York, etc.), and I’m now worried that we’re reinflating a bubble.

Over last weekend, I was talking with a couple of industry friends at the Association Executive Institute meeting in San Antonio. They’re all smart brokers and agents and industry observers. I asked if they thought we’re in a bubble. They all said No; it’s different this time around, while conceding that in some markets, we might be approaching bubblicious territory.

One thing that came out of that discussion, however, is interesting to think about.

In discussing things like the new 3% down mortgage from Freddie Mac, Bank of America, and others, the general sentiment of the industry appears to be that those low down-payment mortgages won’t be a problem this time around because they require high credit scores, documentation, and rational debt-to-income ratios. That may very well be true. But hasn’t our society also changed substantially since the Bubble in one very important way?

The stigma of foreclosure is… what, exactly?

If there is no longer any stigma attached to foreclosure, are these 3% down mortgages something that the intelligent savvy consumer would use strategically? And if so, what do things like credit score and DTI ratios matter?

Let me expand a bit further here.

The Return of the Boomerang Buyer

Back in the ye olde now forgotten days, it was considered shameful to be bankrupt. Similarly, it was considered shameful to have your house foreclosed on. It meant that you were profligate, financially irresponsible, a deadbeat. But then the Bubble happened, and something changed in our national psyche. Not a lot of people talked about it then, and not a lot of people talk about it now, but it really does seem that the stigma of bankruptcy and foreclosure are at least lessened if not gone altogether.

For example, here’s a post from Scott Schang, a mortgage broker who really knows his stuff, about financing a house with a FHA loan after a foreclosure:

2016 FHA GUIDELINES

  • Bankruptcy – You may apply for a FHA insured loan after your bankruptcy has been discharged for TWO (2) years with a Chapter 7 Bankruptcy.  You may apply for a FHA insured loan after your bankruptcy has been discharged for ONE (1) year with a Chapter 13 Bankruptcy
  • Foreclosure – You may apply for a FHA insured loan THREE (3) years after the sale/deed transfer date.
  • Short Sale / Deed in Lieu – You may apply for a FHA insured loan THREE (3) years after the sale date of your foreclosure. FHA treats a short sale the same as a Foreclosure for now.
  • Credit must be re-established no late payments in past 12-24 months, depending on hardship

Application Date must be after the above waiting period to be eligible for FHA financing after hardship.

The FHA, of course, offers low down-payment loans (albeit with PMI and other fees). But the story is similar across the board. And those more lenient attitudes towards people who were foreclosed on is helping the housing market today.

The Washington Post talked about how “boomerang buyers” are back in 2014:

Boomerang buyers who lost a home to a foreclosure or short sale between 2007 and 2013 are projected to make about 10 percent of all U.S. home purchases in 2014, according to John Burns Real Estate Consulting (JBREC). The Washington area is among those regions that are expected to have even higher levels of activity involving boomerang buyers. JBREC expects boomerang buyers to make 17.5 percent of the region’s existing- and new-home purchases this year. According to JBREC, the number of boomerang buyers will increase in 2015 and 2016 as more former owners become eligible for new loans.

I didn’t check to see if really one out of ten home buyers in 2014 were boomerang buyers who had foreclosures but still qualified for a mortgage. But it strikes me as really significant in a subtle, cultural way that so many people are able to get financing so soon after a foreclosure.

Stigma?

I’m certain that most of those who lost their homes during the Bubble were victims of circumstance. I know the popular imagination wants to talk up the stripper with nine condos in Las Vegas (as the movie The Big Short did) but in reality, most of those who lose their homes to foreclosure were not speculators but people who got in over their heads, lost their jobs, and couldn’t make payments. Accordingly, I’m certain that most of the boomerang buyers are folks who just went through a historically rough time along with the rest of the economy.

But having said that, and perhaps because of that, doesn’t it feel like the stigma against foreclosure is gone? It’s hard to think that people who get foreclosed on are lazy deadbeats when you personally know a friend or a relative or six who lost their homes because prices dropped by 40% and the husband lost his job. I mean, can you imagine refusing to invite someone to a party because he’s been foreclosed on?

If the social stigma against foreclosure is gone (or severely decreased) then one really might ask, “What is wrong with foreclosure?” That is, one might ask, “What is wrong with strategic default?”

Consider the Strategic Default in the No-Fault Era

Suppose that you’re a 30-something Millennial buyer. You live in a tough-to-afford housing market, like Westchester County in New York. Realtor.com says that the median closed sale price in a town like New Rochelle, NY is $715K.

As a young professional couple, say you find a $600K starter home – a 3BR/2BA cottage with about 2,000 sq. ft. You take out a 3% down mortgage from BofA or some similar lender, putting down $18K. Your monthly payments would be roughly $2,800.

You decide soon after moving in to just stop paying the mortgage. Because you’re a young finance professional working on Wall Street, you know how the mortgage market works. You know that your mortgage has already been sold off to some pool to be made into a RMBS; the bank that loaned you the money already got its money back, plus a profit. The investment bank that packaged up the loans into RMBS already got paid. The investors who invested in those RMBS already bought mortgage insurance in case of default.

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And your wife is a lawyer who wants to quit her Midtown law firm job to raise your new baby girl. So you decide, “What the hell – let’s just stop paying the mortgage.”

In New York, a judicial foreclosure state, the process of foreclosing on a house could take months, if not years. According to this story, if the New York courts wanted to process all of its pending foreclosures, it would take 30 years. It’s not unusual even in 2016 to hear stories of people living rent-free in their homes for two or three years before the sheriff finally shows up to evict you.

As a matter of fact, the consumer law website Nolo.com has this advice, entitled “The Upside of Foreclosure”:

If, early on, you decide that you don’t want to keep your house and will ultimately be moving on, you may be able to skip payments for many months before the foreclosure process finally begins. And even after the foreclosure sale, chances are great that you can keep living in the house for a while longer free of charge. In all but a few states, you can stay in your house until the new owner gives you a formal written notice demanding that you leave. (See our Summary of State Foreclosure Laws.)

Having payment-free shelter for many months—both before the foreclosure action is brought and after the sale—gives you a golden opportunity to save some money. And that will grease the skids when you do have to find a new place to live.

Huh.

At $2,800 a month, if you strategically default starting with your first payment, you’re out of pocket about $21,000 including your down payment. You live in the house for a year, which is definitely not hard to do anymore. That’s $33,600 in cash you’ve saved up during that year of living rent-free. You net $12,600 in cash from strategic default. If you can drag that year out to two years, which is hardly unknown, you end up with $67,200 in cash at the end of that period.

Sure, your credit takes a hit, but… it’s not clear that in 2016, that’s such a big deal. You can always claim that you were misled by evil mortgage bankers or some such thing, or that the bank refused to renegotiate with you, or whatever. And with a good job, going 12-24 months without a late payment isn’t too difficult. Plus, banks are bending over backwards to offer loans even to people with sub-par credit these days. Wait a few years post-foreclosure, and take all that cash you’ve saved up and do a 20% down conventional for the home you do intend to live in for the rest of your life. (Or better yet, move out of NY metro area to someplace like Kansas City, and pay cash for your next home.)

You could tell your friends and acquaintances that you did this, and not one of them might think badly of you. Indeed, they might think you’re pretty clever to have come up with a way to “work the system” as you did and wonder why they didn’t think of it themselves.

The moral sanction against foreclosure? I don’t know… does that still exist?

So… What Do You Think?

The implications of a change in cultural attitude towards foreclosure are profound. The whole notion that the low down-payment mortgage is safe, as long as the borrower is otherwise creditworthy, is rooted in some notion that Americans generally live up to their obligations. Failing to do so results in not just financial pain, but social stigma. Or used to.

If the moral sanction against foreclosure is now history, like the moral sanction against divorce, then I simply don’t know what prevents massive strategic default the next time the housing market takes a dip.

So… what do you think? Ever talk to your friends and neighbors about foreclosure? Given the general national attitude against banks (“banksters”) and so on, is there still a stigma to foreclosure?

-rsh

 

11 COMMENTS

  1. Many (most?) states are “recourse states” that allow banks to pursue deficiencies after foreclosure. If strategic default by people of means became common, we’d likely see a significant effort to collect on the debts.

  2. Man, you need to take a break, or get some sleep. Credit is more important than ever, and your hypothetical couple will need it to get a rental post foreclosure in the same area as their friends, and they will not be changing jobs with those beat up credit scores, either. Shame is not an “economic emotion”, nor should it be. We have a front running Presidential candidate who has used bankruptcy as an financial tool a number of times in his real estate business. Foreclosures and short sales are in the same category.
    Laws and regulations, not personal morality, govern real estate investment transactions.

  3. ROB,

    For me, so many of your posts are so compelling that, while I try to avoid comment, my gut tells me otherwise. I’ve had an experience with strategic default and here’s what I learned.

    Firstly, what’s being “defaulted” upon is a contract, one with two parties. The borrower, and in this case, the lender.

    Using the time line that you did in your post (2008-2011) and in hindsight, it is evident that the lender didn’t really care why a borrower defaulted, whether it was strategic or hardship. As you know, the “lender” (assuming a large banking entity i.e. Chase, B of A, Countrywide, JP Morgan etc.) never really lent the borrower any money to begin with, they sold the “loan” to become a security either prior to the mortgage origination or shortly thereafter. Meaning the “lender”, unlike the borrower, never had financial exposure to the “loan” in the first place…it was securitized and sold as a CMO or CDO (see “The Big Short”).

    Then when the crash hit, the “lender” was paid again via default insurance, then maybe again through TARP and again as the “pass-through” or Remic was sold to new buyers (in general).

    So, while the guilt of entering into a contract in which I strategically defaulted is ever present, I’ve learned that my counter part, the “lender”, unlike me, doesn’t really care. As my brother, a 40 year ultra-conservative banking executive told me: “we lend money for a living, we assign an interest rate based on risk, we win some and we lose some”.

    At the end of the day I have to live how I handled that contract and the strategy I used to dissolve it. It’s still unsettling, it was against my true character….. it’s something I would never do again.

    That said, I live for experiences, and I now know that while I contributed to the debacle of 2008, the party on the other side of my contract is part of what is arguably the largest fraud in history. For me, that understanding helps me deal with myself and the decision I made.

    While at the time (2008) I took it personally, I now look at it as business, which is how my counterpart looked at it all along.

    On a brighter note…have a good day 🙂

    Thanks,

    Brian

    • Wow, Brian – thank you for your story and your insight. I kind of agree with you on the lender not really taking a risk (and I mentioned it in the article). What’s interesting to me is that you felt (and perhaps still feel) guilt. That’s what I’m wondering about now. If we go through another downturn, and I’m certain that we will go through a downturn someday, would borrowers really feel guilt about strategic default? I’m not so sure. I have a feeling that borrowers today would see this strictly as a business matter, exactly the way the bank does, and *that* bodes ill for these low down-payment mortgages.

      • IMO, anyone that enters into a contract and defaults is guilty and should feel that shame. That’s how big money and its subsequent power works…without it everything breaks down.

        Moral fiber and integrity between parties, in any deal, is the basis for good faith dealings. Again, the only reason I can overcome some of my personal fault is that in this case it turns out that the other side was a worse character than I was….

        If we as a society start to deal with our home mortgage as a no fault, care less agreement that neither party give a s%#t about….then “Katy bar the door”…..The Big Short Part 2

  4. I think we should take a few steps back here. I hope that I am not the only one who views such things as purposely “walking on a mortgage obligation” to be anything more that a flat out indicator of the erosion of the integrity and moral fiber of the consumer. Banks lend money in good faith that they will be paid back for their loan of that money. If that promise for the repayment is absent from the commitment , those who have higher levels of integrity will be harmed by those who do not. I know of people who walked on their mortgage in the downturn even though they had ample resources to pay on their debt. They did so because of the lack of recourse for walking away. In my opinion, those people should have been charged with loan fraud and held up as an example two others of what is no longer acceptable in today’s society. Paragraph impression: Get “strategically” tougher you banks.

    • Ken,

      “a flat out indicator of the erosion of the integrity and moral fiber of the consumer”

      IMO, you’re half right. But in the particular case ROB is discussing, mortgage origination, the counter party to the contract, the lender, was committing fraud on the consumer…they never actually lent anyone any money of their own. They weren’t lending anyone anything “in good faith” they just made the public believe they were.

      Yes, the consumer screwed up and it’s hard to defend anyone that doesn’t own up to their obligation, but in this case the lenders screwed up worse by defrauding the whole system….and getting paid for while doing it.

      So, what the heck does this guy Hickey know anyway? Good question. I worked for a firm call Kidder Peabody back in the late 80’s early 90’s. At the time that firm securitized more mortgage loans than any firm on Wall Street…yes, including good old Goldman Sachs. I was there…I was in it…I was helping create those CMOs.

      Now, the movie (The Big Short) doesn’t start until just pre 2008….but the game had been going on a very long time, since the 1970’s.

      Again, if you haven’t already, go see the movie….it’s the realistic version of how the whole mess was created.

      I agree, a defaulting consumer = bad, but in this case, the Banker/Lender = much, much worse 🙂

      Thanks,

      Brian

      • See what’s kinda interesting is that I don’t even know if you can say the lenders/banks were defrauding anybody either. Consider this — without ANY fraud on anybody’s part, this is how collateralization is supposed to work:

        – Lender makes a loan to borrower
        – Lender sells that loan to syndicator
        – Syndicator packages the loan into a pool, slices it up, and then sells bonds to investors
        – Investors buy the bonds, and also buys mortgage insurance that pays off if the mortgage defaults
        – Insurance company has properly priced the risk of default, and earns premiums, and pays out claims (like GEICO does)
        – Economy turns to crap, so borrower defaults (strategically or not)
        – Insurance company pays off the claim; investor is made whole
        – Insurance company eats the loss, but that’s kind of the whole point of insurance

        There’s nothing fraudulent about any of this. There isn’t anything even bad about this. To a certain extent, even if the borrower strategically defaults, everybody from the lender on up is A-OK, except for the insurance company.

        Should SD become a normal commonplace thing, I suspect that what we’ll see is the insurance companies pricing in the risk of SD and raising the premiums accordingly.

  5. Rob,
    When I started in real estate, 1987, a bankruptcy or foreclosure was 10 yr. black mark on your credit, that quickly moved to 7 yrs., then to 5 yrs.
    Now we are at 2 yrs. or less.
    The change precipitated by the sheer number of people locked out of commerce and the quasi faire attitude of people today. Not many think they did anything wrong by walking away from their debt, most see it as good decision and one that the lenders deserved! They have been rewarded by lenders and the Gov. luring them back to the market place.
    As a person always striving to uphold my “good Texas” upbringing of , pay your debts and be responsible! I like that I have that value!
    I had clients that lost their job and sacrificed everything to hold on to their home, I had others that could care less and lived for years rent free while awaiting to be tossed out with a Gov. check in their pocket.
    I hold many emotions about this subject…and based on the “entitlement” philosophy that abound in society today, I say no, there is no stigma.

  6. I guess I’m just old fashioned. I have never been in any defaults, bankruptcies, etc. I did have a business during 2003-2006 that was impacted by the great recession. So I closed up shop, but kept paying my 100K in business debts. Paid back every single penny, plus interest. It took 9 years, but I did it.

    Does it matter? In a world surrounded by scoundrels, liars and basic dishonesty, I guess not. But, it matters to me. Since I’m the one that has to live with myself and if I had not paid back my debts, I could not live with myself.

    So, here I am in 2016. FICO is over 800. Over $100K in the bank and waiting for house prices to come down here in So Cal, because I feel that they are way, way, way overvalued due to low interest rates and Chinese cash buyers.

    What about all of the other folks like me? Are we the stodgy old farts, the “savers” that the Federal Reserve will decimate in order to bring about their new world order?

    Maybe so, but at least I’ll still be able to sleep at night knowing that I’m doing the right thing, even though it seems like everyone else around me has gone insane.

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