Strategic Defaults and the Foreclosure Crisis by Luke Mullins January 19, 2010

Nearly a year after the Obama administration unveiled its ambitious housing rescue program, foreclosure tallies continue to break records. Foreclosure filings were reported on more than 2.8 million properties in 2009, up 21 percent from the previous year and 120 percent from 2007, according to RealtyTrac. With nearly 10 percent of mortgages now delinquent--which is also a new record--even more homeowners appear headed for foreclosure this year. "A massive supply of delinquent loans continues to loom over the housing market," RealtyTrac CEO James J. Saccacio said in a statement. "Many of those delinquencies will end up in the foreclosure process in 2010 and beyond."

Homeowners have found themselves in foreclosure for a number of reasons. Some purchased properties they could never really afford. Others lost their jobs--the national unemployment rate remains in the double digits--and had no way to make mortgage payments. But as the crisis rumbles forward, an additional driver of home foreclosures has become clear: Many borrowers have the means to keep paying the mortgage but are simply walking away because they believe it's best for their finances.

The number of so called "strategic defaults" more than doubled, to 588,000, from 2007 to 2008, according to a study by Experian and Oliver Wyman. A separate 2009 survey found that more than a quarter of all existing defaults were strategic. Meanwhile, a growing number of academics are touting the financial benefits of walking away. "Homeowners should be walking away in droves," Brent T. White, a University of Arizona law school professor, said in a recent paper. "The financial costs of foreclosure, while not insignificant, are minimal compared to the financial benefit of strategic default."

The case for strategically defaulting is linked to negative equity, or owing more on your home than it is worth. With home prices at the national level having dropped roughly 30 percent from their 2006 peaks--and a great deal more in certain bubble markets--a considerable chunk of property owners are now in this fix. Nearly 1 in 4 borrowers currently have negative equity, according to First American CoreLogic. And rather than continuing to make payments on an investment that's now worth significantly less than what they paid for it, many borrowers are throwing in the towel.

White uses the following example to demonstrate how many borrowers are better off defaulting: A young professional couple with two children pays $585,000 for a three-bedroom, Salinas, Calif.-home in January 2006. At $4,300, monthly payments on their no-money-down, 30-year fixed mortgage with an interest rate of 6.5 percent represent a tad less than 31 percent of their gross monthly income. Toss in taxes, student loans, health care, food, and other essentials, and finances quickly get tight.

After the historic housing bust, their home is now worth $187,000, but they still owe $560,000. Other homes in their neighborhood, of course, have plummeted in value as well. And if the couple was to purchase a similar, nearby house listed at $179,000, their monthly payments would be less than $1,200. That's a huge savings over their current $4,300 monthly mortgage bill. But since a foreclosure on their credit report is likely to prevent them from buying a home in the near-term, they may have to rent. And about $1,000 a month gets them a comparable rental property in their neighborhood.

"Assuming they intend to stay in their home ten years, [the homeowners] would save approximately $340,000 by walking away, including a monthly savings of at least $1,700 on rent verses mortgage payments, even after factoring in the mortgage interest tax reduction," White writes. "If they stay in their home, on the other hand, it will take [the homeowners] over 60 years just to recover their equity--assuming, of course, that they live that long."

The argument against strategically defaulting is much more straightforward: You promised to repay the loan when you took out the mortgage, and it's your responsibility to do everything possible to honor that commitment. Avoiding the guilt and shame that can accompany a foreclosure is one of the top reasons struggling homeowners don't strategically default, White writes. On top of that, a foreclosure significantly damages one's credit--making it difficult, if not impossible, to obtain a mortgage for years afterward.

But in a recent white paper, Alex Edmans, an assistant professor of finance The Wharton School of the University of Pennsylvania, argues that many homeowners are ignoring these consequences to do what they believe is in their best financial interest. "Defaulting on their loan is a rational decision: While they forfeit their home, they rid themselves of a mortgage liability of even greater value," Edmans writes. "The source of the problem is the homeowner's balance sheet: since he has negative equity in his home, it is not worth keeping it by paying the mortgage."

The issue of negative equity triggering strategic defaults represents a nasty headache for the Obama administration. The $75 billion mortgage housing rescue the administration unveiled last February is designed to keep people in their homes by reducing their monthly mortgage payments down to more manageable levels. The plan does not, however, require lenders or servicers to reduce borrowers' mortgage principal--meaning underwater borrowers still have this incentive to walk away from their home loan.

Laurie Goodman, a senior managing director at Amherst Securities Group, considers negative equity to be the housing market's greatest challenge and believes current housing rescue efforts are insufficient. "The current modification program does not address negative equity, and is therefore destined to fail," Goodman said in written testimony before a Congressional committee in December. "It must be amended to explicitly address this problem."

Although Uncle Sam has reduced mortgage payments for more than 850,000 borrowers so far--for a median savings of more than $500--the government will remain under pressure to take more aggressive action as long as the foreclosure epidemic keeps churning. Mark Zandi, the chief economist at Moody's Economy.com, believes the government may take steps to tackle the issue of negative equity head-on this year by incorporating principal write downs--which reduce a borrower's negative equity position--into the housing rescue program.

What Home Sellers Don't Tell Buyers

By M.P. MCQUEEN

As buyers ease back into the battered real-estate market, they're often hitting a stumbling block: fibbing by home sellers.

Eager to unload their abodes, some sellers exaggerate the size of their lots or their houses. Others minimize their property-tax or utility bills, conveniently forget about pests, or downplay flooding problems or noise.

Real-estate experts say that while such misrepresentations aren't new, the tough market of the past few years has made buyers more wary, partly because they can't expect rising home prices to bail them out of costly mistakes. As a result, deals are taking longer, and more of them are falling apart as buyers find properties sometimes aren't all they're supposed to be.

More than 30 states have disclosure laws requiring sellers to tell prospective buyers and agents about leaky roofs and other problems, according to the National Association of Realtors. But there's often a gray area involving the disclosure of problems the seller may not know about, such as a long-ago flood or hidden mold.

States are also increasingly passing laws requiring homeowners to disclose environmental issues, such as the presence of radon gas, a contaminant linked to lung cancer, and underground fuel tanks. In California, the checklist of required disclosures is so long that a cottage industry has sprung up of firms that help sellers prepare the forms.

Given the complexity of disclosure laws, it's not surprising that potential buyers don't hear about every problem in a house. Besides the issue of fibbing, sellers may genuinely not know about problems. And even if they do, the laws generally don't apply to bank-owned homes transferred in foreclosures, which now constitute a larger share of sales.

Buyers need to do their own due diligence and not rely exclusively on what sellers and agents say. They should hire an independent home inspector or home-inspection engineer, one not referred by the seller—and be aware that real-estate agents typically represent the seller.

Here are some of the common misrepresentations and white lies that buyers may hear as they shop for a house, according to real-estate experts and state regulators:

• "This house is on two acres." Disputes about property dimensions—how many square feet in a house or condo, or its exact boundaries—are common. Sometimes buyers don't learn the exact dimensions until the lender's appraisal.

How to Learn More About a Home

If you want to know more about a home's history of property damage, you can ask the seller to provide you with a copy of his or her C.L.U.E., or Comprehensive Loss Underwriting Exchange report from LexisNexis at www.choicetrust.com. A Home Seller's Disclosure report lists claims for property losses, such as fire damage, from the last 5 years as reported by insurance companies at the stated address, but doesn't disclose personal information such as the homeowner's social security number or date of birth. The seller's disclosure report can tell you about problems that might affect the availability or price of homeowners insurance, including claims for fire or hail damage. It costs $19.50, but homeowners also can obtain a free annual personal property report, which lists a 7-year history of losses associated with both the property and the individual, under the federal fair credit act. No claims in the last 7 years will produce a clean report.

A similar loss report, called A-PLUS, is available from the Insurance Services Office, Inc. or 800-627-3487.

Listing agents usually accept a seller's word on property dimensions, says Diane Saatchi, a senior vice president at Saunders & Associates, a real-estate firm in Bridgehampton, N.Y. "We tell everyone to verify," she says. Smaller dimensions also can cause an appraisal to come in lower than the agreed-upon purchase price. Low appraisals are a leading cause of ruined deals in today's market. A properly worded appraisal contingency in the purchase contract would allow you to scuttle the deal or find other financing if the appraisal comes in low, says New York real-estate attorney Michael Xylas.

• "We don't have pests." A basic home inspection generally doesn't include a peek inside walls or underground for termites and mold, which are among the top complaints. Inspections for mold and radon gas also generally aren't included; usually buyers must order these inspections separately. Other inside-the-wall problems include faulty wiring and old plumbing, which also may require specialists.

James Holtzman, a financial adviser at Legend Financial Advisors Inc. in Pittsburgh, says sellers of the 1901 house he bought in August 2006 said its electrical wiring was completely upgraded, yet an electrical inspection revealed only one of three floors had been totally upgraded. The seller then knocked $6,000 off the sales price before they went to contract so Mr. Holtzman, 35 years old, could pay for the necessary work.

• "This place never floods." Even arid states such as Arizona and New Mexico have occasional flash floods, and water and drainage problems aren't always obvious. June Walbert, 52, a certified financial planner at USAA, a financial-services company, says her San Antonio house received a clean bill of health from a home inspector before she bought it six years ago. But 10 days after she moved in, the sewer backed up, flooding the house, and she had to fork over $2,800 for repairs. "It was a rude surprise," says Ms. Walbert, who adds she asked her home inspector and the seller for compensation, but didn't get it.

Bill Richardson, outgoing president of the American Society of Home Inspectors, says a general home inspection wouldn't catch that unless the sewer line was visible from the basement or water backed up into sinks and tubs or toilets.

• "Taxes and maintenance costs are low." Home buyers often gripe about tax and utilities bills that are higher than sellers said they were. Homeowner association and condo dues and assessments are also common complaints. Sometimes sellers simply underestimate the bills, or forget to include recent or expected increases, agents and brokers say. Taxes can also be deceptively low because of unrecorded improvements like decks and finished basements. Ask to see recent bills, and check with the tax assessor's office for up-to-date information.

• "This is a quiet neighborhood." Sellers may play down distractions that could drive you crazy, such as barking dogs or idling buses. A charming park by day could be a teen hangout at night. Your best bet is to view a property at different times of the day. "I can't tell you how many times in my career buyers didn't go there in the night time, even though I told them to. You spend more time in the house at night than during the day," says Ms. Saatchi, the New York real-estate agent. Talk to neighbors and peruse the local newspapers and blogs to get a feel for a place, and check with police for crime.

• "There's going to be a golf course, a pool and a party room." Builders of many developments that broke ground during the housing boom ran out of money before the project was completed. Many homeowner and condo associations also are strapped because of delinquencies and defaults. Some states require upfront disclosures about this, but you should also ask neighbors, not just sellers, about any promised facilities. Also, check titles to be sure that specific parking spaces, storage units or other facilities are included in a property sale.

Write to M.P. McQueen at MP.McQueen@wsj.com

You can't file for your $8,000 homebuyer tax credit by Les Christie of CNNMoney.com

By Les Christie staff writer

January 15, 2010: 11:40 AM ET

NEW YORK (CNNMoney.com) -- Did you purchase a home after Nov. 6? Don't expect your $8,000 homebuyer tax credit any time soon.

UPDATED: IRS releases new form, begins accepting claims again

Since Congress passed the tax credit last February as part of the stimulus program, more than 1.4 million buyers have scrambled to take advantage of it, according to the IRS.

All they had to do was file an amendment to their 2008 tax returns (the ones they filed last spring) and claim the promised refund of 10% of the purchase price -- up to $8,000.

"I closed on a Friday and I filed an amendment to my taxes on Monday," said Valatisha Jacinto, who purchased her Waco, Texas, home last March.

But that all changed on Nov. 6.

One CNNMoney.com reader wrote: "I bought a new home to get the $8,000 tax credit like many others. However the IRS has NOT ALLOWED ANYONE TO FILE since November 6th!! It has been over 2 MONTHS!!"

He's right. Nov. 6 marked the date that the rules changed because an extended -- and expanded -- version of the homebuyer tax credit went into effect. And that put filing for the credit on hold.

What I did with my $8,000 tax credit

Originally, the credit was just good for first-time buyers and was slated to end on Nov. 30. But Congress extended the credit to include contracts signed by April 30 and closed by June 30. It also made a refund of up to $6,500 available to existing homeowners looking to buy something new.

And that marked the start of a new IRS paperwork wrangle.

Those homeowners who closed their sale before Nov. 6 use Form 5405 to claim the credit right away. But those closing after that date are in limbo because no form yet exists for them to file.

The IRS had been expected to come out with a revised form by early January, but it has yet to release anything.

Robert Dietz, an economist with the National Association of Home Builders who has been monitoring the situation, said the delay may be caused because numerous parties, including the Treasury Department, have to agree on how to process all the new documentation that the expanded tax credit requires. Whereas before, all you did was file a form saying you'd bought a house -- no proof required.

Now, for example, existing homeowners buying new places must provide proof that they owned and resided in their previous homes for at least five of the past eight years.

"They may just be making sure all their i's are dotted and their t's are crossed before they release it," Dietz said.

No e-filing for homebuyers

Even after the new form is ready, new filers will still face delays. Anyone who wants to claim their first-time homebuyer tax on their 2009 taxes (the ones being filed now through April 15) can't do it it electronically. That's right: Back to paper filing.

Part of that change is because the IRS has become more concerned about fraud as it discovers more people claimed the tax credit without actually purchasing property.

In October, a tax preparer, James Otto Price III, was the first person convicted of this crime. He falsely claimed the credit for 15 clients.

"Because of the scams, the IRS started sending back the amended returns and asking for proof," said Mary Mellem of David & Mary Mellem, EAs & Ashwaubenon Tax Professionals.

The IRS, she said, now requires a signed copy of the settlement statement ( HUD-1), plus a signed mortgage statement with the new address and a copy of either the taxpayer's drivers license, bank statement or pay stub, showing the new address. That paperwork slows the process.

"The system has no way of sending along the documents they're requiring," said Mellem. "Taxpayers must file a paper return instead."

The IRS points out that taxpayers can still use the electronic forms available on its Web site; they just have to print them out, attach the proof and mail everything in. And that can take quite a while.

"Taxpayers are looking at another three months before they get their returns," said Mellem.

1248 Phyllis Avenue, Mountain View Available as a "Pocket Listing" to be on MLS soon

Held as a "pocket" listing currently, this lovely property is available for sale and will be on the MLS soon.

1248 Phyllis Avenue, Mountain View

1248 Phyllis Avenue, Mountain View

• Excellently located on the west side of El Camino Real in South Mountain View.
  
• 3 bedrooms / 2 bathrooms completely remodeled home in 2008.
  
• Dual paned, low emission windows throughout.
  
• Gorgeous new interior and exterior doors.
  
• Travertine tile fireplace goes all the way to the ceiling.
• Area above fireplace flat screen ready with electrical and cable hookup.
• Sparkling quality hardwood floors.
• Living room boasts amazing wall of windows.
  
• New composition roof.
• All new kitchen includes:
  
• Custom maple cabinetry with glass fronts.
• Pull out drawers in lower storage cabinetry.
  
• Solid granite slab counter tops.
• Stainless steel main sink and vegetable prep sink.
• GE Monogram wine refrigerator with smoky glass front.
• GE Monogram six burner stove and hood.
• GE Monogram professional refrigerator, freezer on bottom.
• GE Monogram dishwasher.
• Custom diamond shaped travertine tile backsplashes.
• Extended eat at bar island.
  
• All new bathrooms include:
• Italian tile floors and walls.
• Granite counter tops.
• Designer sinks.
• Toto toilets.
• New sprinkler system around entire home.
• Tasteful and appealing new landscaping around entire home.
• New concrete stamped and custom dyed driveway, front walkway,side patio and rear patio.
• Sliding glass doors from each exterior room to rear yard.
• Laundry area in garage.
• New heating ducting. (Furnace in attic.)
• New water heater.
• Recessed lighting throughout home.
  
• This home is fully permitted and ready for you to enjoy!
  

Priced at $1,049,000

I'm happy to answer any questions you may have on the home.
(650) 483-2055 cell..Deniece

U.S. Department of Housing and Urban Development (HUD)

U.S. Department of Housing and Urban Development (HUD)

FHA ANNOUNCES POLICY CHANGES TO ADDRESS RISK AND STRENGTHEN FINANCES

New Measures Will Help FHA Better Manage Risk, While Maintaining Support for the Housing Market and Access for Underserved Communities

WASHINGTON – Federal Housing Administration (FHA) Commissioner David Stevens today announced a set of policy changes to strengthen the FHA’s capital reserves, while enabling the agency to continue to fulfill its mission to provide access to homeownership for underserved communities. The changes announced today are the latest in a series of changes Stevens has enacted in order to better position the FHA to manage its risk while continuing to support the nation’s housing market recovery.

The FHA will propose to take the following steps: increase the mortgage insurance premium (MIP); update the combination of FICO scores and down payments for new borrowers; reduce seller concessions to three percent, from six percent; and implement a series of significant measures aimed at increasing lender enforcement. U.S. Housing and Urban Development Secretary Shaun Donovan previewed the changes in December of last year, noting that the FHA would announce additional details before the end of January.

“Striking the right balance between managing the FHA’s risk, continuing to provide access to underserved communities, and supporting the nation’s economic recovery is critically important,” said Commissioner Stevens. “When combined with the risk management measures announced in September of last year, these changes are among the most significant steps to address risk in the agency’s history. Additionally, by continuing to provide affordable, responsible mortgage products, FHA will support the housing market’s recovery. Importantly, FHA will remain the largest source of home purchase financing for underserved communities.”

Announced FHA Policy Changes:

1. Mortgage insurance premium (MIP) will be increased to build up capital reserves and bring back private lending
   • The first step will be to raise the up-front MIP by 50 bps to 2.25% and request legislative authority to increase the maximum annual MIP that the FHA can charge.
   • If this authority is granted, then the second step will be to shift some of the premium increase from the up-front MIP to the annual MIP.
   • This shift will allow for the capital reserves to increase with less impact to the consumer, because the annual MIP is paid over the life of the loan instead of at the time of closing
   • The initial up-front increase is included in a Mortgagee Letter to be released tomorrow, January 21st, and will go into effect in the spring.
     
     
2. Update the combination of FICO scores and down payments for new borrowers.
   • New borrowers will now be required to have a minimum FICO score of 580 to qualify for FHA's 3.5% down payment program. New borrowers with less than a 580 FICO score will be required to put down at least 10%.
   • This allows the FHA to better balance its risk and continue to provide access for those borrowers who have historically performed well.
   • This change will be posted in the Federal Register in February and, after a notice and comment period, would go into effect in the early summer.
     
     
3. Reduce allowable seller concessions from 6% to 3%
   • The current level exposes the FHA to excess risk by creating incentives to inflate appraised value. This change will bring FHA into conformity with industry standards on seller concessions.
   • This change will be posted in the Federal Register in February, and after a notice and comment period, would go into effect in the early summer.
     
     
4. Increase enforcement on FHA lenders
   • Publicly report lender performance rankings to complement currently available Neighborhood Watch data - Will be available on the HUD website on February 1.
     • This is an operational change to make information more user-friendly and hold lenders more accountable; it does not require new regulatory action as Neighborhood Watch data is currently publicly available.
   • Enhance monitoring of lender performance and compliance with FHA guidelines and standards.
     • Implement Credit Watch termination through lender underwriting ID in addition to originating ID.
     • This change is included in a Mortgagee Letter to be released tomorrow, January 21st, and is effective immediately.
   • Implement statutory authority through regulation of section 256 of the National Housing Act to enforce indemnification provisions for lenders using delegated insuring process
     • Specifications of this change will be posted in March, and after a notice and comment period, would go into effect in early summer.
   • HUD is pursuing legislative authority to increase enforcement on FHA lenders. Specific authority includes:
     • Amendment of section 256 of the National Housing Act to apply indemnification provisions to all Direct Endorsement lenders. This would require all approved mortgagees to assume liability for all of the loans that they originate and underwrite
     • Legislative authority permitting HUD maximum flexibility to establish separate "areas" for purposes of review and termination under the Credit Watch initiative. This would provide authority to withdraw originating and underwriting approval for a lender nationwide on the basis of the performance of its regional branches

In addition to the changes proposed today, the FHA is continuing to review its overall response to housing market conditions, and continuing to evaluate its mortgage insurance underwriting standards and its measures to help distressed and underwater borrowers through FHA/HAMP and other FHA initiatives going forward.

###

HUD is the nation's housing agency committed to sustaining homeownership; creating affordable housing opportunities for low-income Americans; and supporting the homeless, elderly, people with disabilities and people living with AIDS. The Department also promotes economic and community development and enforces the nation's fair housing laws. More information about HUD and its programs is available on the Internet at www.hud.gov and espanol.hud.gov.

Brandon Knapp's Market Update 1/19/10

Brandon Knapp, Branch Manager/Owner of RPM Mortgage in Campbell, CA provides an analysis of the mortgage market for the week.

Brandon Knapp's Market Update 1/19/10