Up until now about the only thing preventing millions of homeowners from strategically defaulting on their home was the moral dilemma many of them faced. With as many as 1/3 of the nations 45 million homeowners currently upside-down in their homes (owing more than they can sell it for), lenders fear that a 3rd (or 4th, depending on how you keep track) wave of foreclosure activity could be launched by millions of owners simply walking away. They can afford to make the payments but the strategic argument is that they can re-build their credit and build equity in a new home faster than they can recover the lost equity in their homes – especially if it’s $200,000, $400,000 or more.
The position has been detailed in a much-hyped white paper by University of Arizona Professor Brent White which I explored some time back in Social Control of the Housing Crisis vs Strategic Default. It can be a tough argument to refute – when somebody is making payments on a home they bought for $600,000 while their neighbor just bought the same property as an REO for $285,000. The only thing keeping them there is the sense of moral obligation because they are honorable folks who signed a contract and gave their commitment that they would. At what financial point does that moral obligation start to break down? And if you can make the argument that the lenders themselves had some culpability in the run-up and subsequent collapse (an argument that is pretty easily made), then does that provide even further justification for underwater homeowners to simply bail?
Now Fannie Mae has decided to ‘put some teeth’ into their enforcement and take some pre-emptive action on strategic defaults in what they’re terming a ‘get tough’ strategy. They have notified their lenders that effective next month they should begin monitoring loans facing foreclosure and issuing recommendations in cases that might constitute strategic default for possible pursuit through deficiency judgments. Of course deficiency judgments only work in states that allow such a thing. California doesn’t so that avenue is closed off to them here. They can still pursue deficiency judgments here if the owner re-fi’d but the California Association of Realtors is looking to shut down that avenue as well with SB1178, which just passed the Senate and is working through the Assembly as we speak. Of course as I’ve explained that one before, if you did a cash-out refi, you’ll still be on the hook but if you re-fi’d just to get a better interest rate you’ll dodge another bullet the lenders are aiming your way.
So what else has Fannie got up there sleeve for this get-tough policy? Well, if it appears you exercised a strategic default then Fannie will not guarantee anothernloan for you for 7 years. As of right now, the policy is if you exercise your options for a loan-mod, short-sale or deed-in-lieu, and can show extenuating circumstances (job loss, illness or divorce), then Fannie might give you a new loan in as little as 2-3 years with 10% down, 20% down if you exercised your options but have no extenuating circumstances.
Is that enough get-tough toothiness to make a difference? Well, if Freddie joins in it could be. With the government backing or directly involved in 95% of the mortgage market today, that could be sufficient incentive to try to work within the system instead of dumping on the system. Innstates where there is recourse it’s even tougher – although there’s a reason why most lenders avoid judicial foreclosure as an option today. It’s expensive and time consuming and leaves savvy homeowners in their homes free far longer than otherwise. With the nationwide average already running 18 months, does Fannie really want to stretch that out even more?
Well, I certainly don’t have the answers to that – it’s tough enough coming up with the questions. Having just gone through an exercise in financing myself, I can’t imagine a much more exhausting, convoluted scenario of an industry in disarray. Then you have to wonder if Fannie will even be here next year or if this is just a last ditch effort to forestall the wave that would put them under.
If you’re $400,000 upside-down in your home I’d love to hear what you think and why you’re gritting it out.