By Ilyce Glink and Samuel J. Tamkin
Q: I am a CPA (retired). When the subject of underwater homeowners comes up, it seems that advice on this matter always ignores one truth that deserves to be told. When one takes out a mortgage to purchase a home, there are several facts that line up to make the purchase reasonable:
2) The buyers can afford the mortgage payment. Does it fit their income? The lender usually makes sure of that.
3) After making 360 payments (for example), the buyers will own the home they desired and have no further debt.
It may be worth a bit less than they hoped at that point, but who should underwrite that disappointment?
If you graphed, over 360 months, mortgage balance, market value and equity, one thing is certain: Regardless of how market value intersected and flirted above and below the mortgage balance line, the exact thing that happens at the end is the only thing the owners should reasonably expect to happen, namely that they own that particular home!
The various graph intersections and negative relationships over that time are nothing more than historical footnotes and markers for periods of stomach acid. If a person has cash available, as one of your recent letter-writers did, and still has the current income to service the mortgage, as they also did, "bailing out" is unethical and a breach of a promise. If one's income no longer supports the payment, or life requires they sell the house (job relocation, etc.), then short sale may be needed and honorable.
Defaulting on a loan because the homeowner temporarily regrets their choices is not a choice that should have few negative implications. If I buy some stocks for my retirement that do not perform as I hoped, where is my bailout? It simply is not a valid argument. I am tired of the removal of the onus from such actions.
A: There have been a lot of mixed feelings about what has happened to the real estate market over the past 10 years. But let's not forget what's at the center of it: inappropriate loans were made to people who could not afford them. The banks resold those subprime loans, with a supposed AAA rating (in reality, the portfolios were of considerably less quality) back to Fannie Mae, Freddie Mac and FHA, and those loans were resold all over the world.
Fannie and Freddie were put into conservatorship, where more than $180 billion of taxpayer funds was used to stabilize the secondary mortgage market, on which the U.S. housing market depends and which is also a source of stability for investments overseas.
After U.S. financial services markets sliced and diced those questionable loans and sold them all over the world (remember CDOs?), we hit a tipping point, and the Great Recession started. Which leads us back to your question.
Why do people borrow more than they can afford? We think it's because up until now the housing market (including real estate agents, mortgage lenders, etc.) has been primed to sell home buyers on the future, not the present.
When we bought our first home, nearly 25 years ago, we were told to "buy to the maximum" that someone would lend us. We were told that our "incomes were sure to rise" and someday the house would be cheap for us. The condo we bought cost $144,000 in 1989, and our mortgage interest rate initially was 11.75 percent.
It worked out well for us, and for millions of others who bought judiciously (no, we didn't overspend) and didn't run headfirst into a housing crisis, where home prices fell as much as 60 to 70 percent and took years to recover. (And, in some markets, there are neighborhoods where home prices in 2014 remain 40 to 60 percent below the price homeowners paid in 2005 and 2006.)
We don't believe that most homeowners who went through a short sale or foreclosure walked away with a pot of cash unless they were part of the original wave when lenders paid them to move, or unless the lender accepted a deed-in-lieu of foreclosure.
Buying a home isn't an ethical contract, it's a business deal bound together with about 80 pages of legal mumbo-jumbo. At the heart of it, the contract says you agree to pay back this loan and if you don't, the lender gets the property and in some cases has the right to sue the borrower for any unpaid balance.
Every day, companies sign the same type of mortgage documents and make the same deal. If they don't pay back the loan, the lender gets the property. Falling victim to the worst recession since the great Depression doesn't make you a bad or unethical person.
But you are on the losing side of the deal. Except that when the property is worth about 40 percent of what it was when you bought it, the lender is also on the losing side of the deal. And then the taxpayers who bail out the financial institutions also lose.
In our view, we're only slowly working our way out of this downward spiral. True, Fannie Mae and Freddie Mac have generated enough profits to finally repay the American taxpayers (though not yet with interest). And FHA is finally refilling its coffers. But not enough Americans are back to work and many of those who are working earn less than they were before. Ten million homeowners are still underwater with their mortgages, which makes them much less likely to move to get a new job. And we're only building about 450,000 new homes a year, or about half of what the country should be generating.
In short, we've got a long way to go. In another year or two, we'll have worked our way through the backlog of foreclosed homes. Prices will begin to rise again, but slowly. More homes will be built and jobs will be created.
At the heart of the recovery will be the new "ability to repay" rule that lenders must use for most of their loans: You truly have to have the income to repay your mortgage. You won't be able to get a loan for $500,000 when you only earn $50,000, as was the case back in 2003 and 2004.
Finally, we don't think people default on the mortgages because of a temporary regret. This recession has destroyed a significant portion of wealth for middle-class families, most of whom bled their 401(s) and IRAs dry before succumbing. And the fact is, almost no one stays in a house for 30 years anymore. The typical mortgage has a lifetime of seven years and over the decade; that fell to 18 months for a while. Most Americans move every five to 10 years, either to take a job, find a new school district for their family, marriage, divorce, or death.
Unfortunately, we believe this unique destruction of wealth will have a profound impact on millions of lives for a generation to come.
Thanks for your comment.
(Ilyce Glink is the creator of an 18-part webinar and ebook series called "The Intentional Investor: How to be wildly successful in real estate," as well as the author of many books on real estate. She also hosts the "Real Estate Minute," on her YouTube.com/expertrealestatetips channel. If you have questions, you can call her radio show toll-free (800-972-8255) any Sunday, from 11a-1p EST. Contact Ilyce and Sam through her website, http://www.thinkglink.com.)
(c) 2014 ILYCE R. GLINK AND SAMUEL J. TAMKIN. DISTRIBUTED BY TRIBUNE CONTENT AGENCY, LLC.