Bank of America made headlines with its principal forgiveness program. The real news is that they are preparing to blast debtors out of their bunkers of entitlement.
Today's featured property is another epic HELOC abuser. Should these people qualify for principal reduction?
Irvine Home Address … 17 CARRIAGE Dr Irvine, CA 92602
Resale Home Price …… $715,000
The more I know, the less I understand
All the things I thought I knew, I'm learning again
I've been tryin' to get down
to the heart of the matter
But my will gets weak
and my thoughts seem to scatter
But I think it's about…forgiveness
Even if, even if you don't PAY me anymore
Don Henley — The Heart of the Matter
Lenders are trying to figure out how their massive Ponzi Scheme collapsed. They are relearning lending again because everything they thought they knew was wrong. When you get down to the heart of the matter, borrowers are carrying too much debt which is killing them financially and emotionally. It is about forgiveness. Even if it means debtors don't pay anymore.
Forgiveness never comes easy, and in lending it never comes cheap. These debts will be forgiven, and the toxic loans that spawned them will be cleansed from the system — mostly through foreclosure. Home debtors are hoping for principal forgiveness without consequence. That isn't going to happen. Lenders only forgive as a last resort, and there are consequences for the borrower. When it's done, lenders turn to the US taxpayer to make them whole again.
A 600% increase in foreclosures
I attended a local Building Industry Association conference on Friday 26 March 2010. The west coast manager of real estate owned, Senior Vice President Ken Gaitan, stated that Bank of America, which currently forecloses on 7,500 homes a month nationally, will increase that number to 45,000 homes per month by December of 2010.
After his surprising statement, two questioners from the audience asked questions to verify the numbers.
Bank of America is projecting a 600% increase in its already large number of monthly foreclosures.
This isn't unsubstantiated rumor; this comes straight from one of the most powerful men in Bank of America's OREO department (yes, that really is what they call it). It appears they have too many properties already.
Perhaps this is a good time to start a Trustee Sale service…. One of the panelists who works for a building company said he was flipping houses with his personal money. He noted that in some markets, he can buy a house at auction for less money than builders are paying for finished lots. That is a bit crazy.
There was encouraging news from some in the reality-based community at the conference. Builders are buying up projects in Southern California, so the land market has found a bottom. Prices are still speculative, but the builders are buying to have buildable inventory, so in select markets real demand exists for finished lots and properties with partial improvements.
There was a certain amount of positive spin at the event, which is natural given the beleaguered stated of the Southern California building industry. Jeff Collins at the OC Register covered the more bullish opinions.
It is still not enough
Last week I noted that Lenders Start More Foreclosures to Catch Up with Delinquencies. Consider the size of the problem: 1.2 million Bank of America homeowners are in default. Even if they forclosed on 45,000 a month for a full year, that is only 540,000 foreclosures. What about the other 660,000 people in default? I think their number — large as it may seem — is actually wishful thinking. It is worse than that. (thanks jules)
Principal reductions are a public relations diversion
Everyone is abuzz with the news that Bank of America is forgiving principal. As you might imagine, many will apply and few will be helped. Moral hazard dictates that irresponsible borrowing that results in free money will cause more irresponsible borrowing; after all, it isn't borrowing, it's a gift. If banks start giving away money, everyone will do whatever is necessary to obtain it.
I contend the principal reduction program is a public relations diversion. Let's look at the numbers. By Bank of America's own admission, the program will assist 45,000 customers — a sum equal to the monthly foreclosure rates they are anticipating by the end of the year. If they are foreclosing on more people each month than would be helped by the principal reduction program, then the program is merely a pleasant facade intended to divert attention from the huge volume of foreclosures they will push through.
The program, while limited in scope and available by invitation only, signals a significant shift in efforts to deal with the millions of homeowners who are facing foreclosure. It comes as banks are being urged by the White House, members of Congress and community groups to do more to stem the tide.
The Obama administration is also studying whether to provide more help to people who owe more on their mortgages than their homes are worth.
Bank of America’s program may increase the pressure on other big banks to offer more help for delinquent borrowers, while potentially angering homeowners who have kept up their payments and are not getting such aid.
You think? Responsible borrowers should be pissed. The more irresponsible and foolish borrowers were, the greater their principal forgiveness.
As the housing market shows signs of possibly entering another downturn, worries about foreclosure are growing. With the volume of sales falling, prices are sliding again. When the gap increases between the size of a mortgage and the value that the home could fetch in a sale, owners tend to give up.
Cutting the size of the debt over a period of years, however, might encourage people to stick around. That could save homes from foreclosure and stabilize neighborhoods.
“Banks are willing to take some losses now to avoid much greater losses later if the housing market continues to spiral, and that’s a sea change from where they were a year ago,” said Howard Glaser, a housing consultant in Washington and former government regulator.
The threat of a stick may be helping banks to realize that principal write-downs are in their ultimate self-interest. The Bank of America program was announced simultaneously with the news that the lender had reached a settlement with the state of Massachusetts over claims of predatory lending.
The program is aimed at borrowers who received subprime or other high-risk loans from Countrywide Financial, the biggest and one of the most aggressive lenders during the housing boom. Bank of America bought Countrywide in 2008.
Bank of America is trying this principal reduction program with Option ARM holders because they know these people are all going to default. Anything they can do to minimize the losses on these properties, including delaying foreclosure and hoping for appreciation, is preferred to absorbing these losses when prices are very low. Of course, it will not work, but it it worth a shot. They have little to lose by trying.
Borrowers have nothing to lose either. The Bank of America program is an attempt to stop the hopelessly underwater from strategically defaulting. It is their only hope.
The devil is in the details
Bank of America officials said the maximum reduction would be 30 percent of the value of the loan.
Those people who are more than 30% underwater are considered the walking dead. They should default. If you don't qualify for this program because you are too far underwater, what hope do you have?
I heard recently that Hemet, California, has a significant number of borrowers more than 50% underwater. Back in 2006-2007, I was involved with the Valley Economic Development Corporation working to bring business to Hemet and San Jacinto. I remember a brochure we created touting the relative affordability of local housing. At the time, the median income was $45,000 per year, and the median home price was $405,000.
Most who paid $405,000 for a house back then used Option ARMs because they could leverage nine-times their income to obtain a property. Now that the median home price is around $175,000 — which is close to four-times income — many residents owe more than double what their house is worth.
They said the program would work this way: A borrower might owe, say, $250,000 on a house whose value has fallen to $200,000. Fifty thousand dollars of that balance would be moved into a special interest-free account.
As long as the owner continued to make payments on the $200,000, $10,000 in the special account would be forgiven each year until either the balance was zero or the housing market had recovered and the borrower once again had positive equity.
Let's see how a Southern California borrower would be effected by this program. Let's assume a $500,000 house price and a $400,000 first mortgage with a $100,000 second. The second is not subject to this agreement, so we already have our first major hurdle to overcome. When Bank of America lowers the value of its first mortgage, are they taking into account the indebtedness of the second? If they don't, payments are still not affordable.
Assume the borrower received $200,000 in potential principal reduction. Now they are paying on a $200,000 first and a $100,000 second which brings their combined loan-to-value under 100%. The $200,000 of deferred principal gets reduced by $10,000 a year until values increase. Absent appreciation, it will take 20 years to dig out. That is a long time to rent their home from the bank with zero equity.
Here is where it gets fuzzy — on purpose I'm sure — Let's say the borrower stays with the program for ten years. The deferred principal is now $100,000, and the total indebtedness is $400,000 minus amortization. Let's further assume that prices have appreciated, and the property is now worth $400,000. What happens?
- Does the principal forgiveness end and the account with the principal deferment is permanently fixed at the point of crossover? How do we know when this occurs? Is Bank of America going to order yearly appraisals just prior to forgiving the debt to make sure the owner is still underwater?
- Once Bank of America discovers the borrower is no longer underwater, can they recapture forgiven principal if the borrower continues to live in the property? In short, does the bank get the appreciation to recover the forgiven debt, or does the borrower get to keep it?
- How is this deferred principal paid off? Is this a permanent zero-interest loan paid off when the property is sold? Does the deferred principal get added back to the original mortgage once the borrower is no longer underwater? What happens to the borrower's payment?
If those questions are resolved in favor of borrowers, I would be surprised. To the degree that the borrower benefits is the degree to which moral hazard is encouraged.
Too little too late
Bank of America said its new program would initially help about 45,000 Countrywide borrowers — a fraction of the 1.2 million Bank of America homeowners who are in default. The total amount of principal reduced, it estimated, would be $3 billion.
The bank said it would reach out to delinquent borrowers whose mortgage balance was at least 20 percent greater than the value of the house. These people would then have to demonstrate a hardship like a loss of income.
These requirements will, the bank hopes, restrain any notion that it is offering easy bailouts to those who might otherwise be able to pay. “The customers who will get this offer really can’t afford their mortgage,” Mr. Schakett said.
LOL! Every borrower in Bank of America's books is going to seek a bailout. That is moral hazard! That is why you don't bail people out. The only way to discourage this is to create a program nobody qualifies for… I guess they did that, didn't they?
But Steve Walsh, a mortgage broker [LOL!] in Scottsdale, Ariz., who said he had just abandoned his house and several rental properties, called the program “another Band-Aid. It probably would not have prevented me from walking away.”
That is the other problem Bank of America must contend with. Many of the people who took out these loans were speculators who are going to walk no matter the terms because their speculative venture did not turn out as planned.
… Reducing principal is widely endorsed, in theory, as a cure for foreclosures. The trouble is, no one wants to absorb the costs. [No kidding?]
When the administration announced a housing assistance program in the five hardest-hit states last month, officials explicitly opened the door to principal forgiveness. Despite reservations expressed by the Treasury, the White House and Housing and Urban Development officials have continued to study debt forgiveness in areas with lots of so-called underwater homes, according to two people with knowledge of the matter.
"Continued study" is code for "we are not going to do anything, but we want you to think that we might." It is part of the dangling-carrot policy designed only to keep debtors paying.
On a national scale, such a program risks a political firestorm if the banks are unable to finance all the losses themselves. Regulators like the comptroller of the currency and the Federal Reserve have been focused on maintaining the banks’ capital levels, which could be hurt by large-scale debt forgiveness.
“You have to be very careful not to design a program that would change people’s fundamental behavior across the country in a destabilizing way or would be widely perceived as unfair to people who are continuing to pay,” Michael S. Barr, an assistant secretary of the Treasury, said early this year.
Moral Hazard can't be avoided
No program exists, nor can one be designed, that does not create moral hazard and gross unfairness. That is why this issue is so difficult.
This process must be allowed to run its course. Bank of America will manage its public relations and try to look like they are working to prevent foreclosures.
In reality, Bank of America is gearing up to remove the loan owners and squatters. Expect to see a steady increase in foreclosures all year continuing for the foreseeable future.
Should we give HELOC abusers principal reductions?
The owner of today's featured property would likely qualify under the terms of the Bank of America agreement. Let's take a careful look at the behavior of these borrowers and see if this is something we should encourage with bailouts and handouts.
- This property was purchased on 7/30/199 for $348,500. The owners used a $313,350 first mortgage and a $35,150 down payment.
- On 10/14/1999 they obtained a HELOC for $30,000 which allowed them to withdraw their down payment.
- On 3/7/2002 they opened a HELOC for $50,000.
- On 3/28/2003 they refinanced their first mortgage for $322,000.
- On 3/17/2004 they obtained a HELOC for $120,000.
- On 10/26/2004 they refinanced their first mortgage for $462,750.
- On 10/12/2006 they refinanced their first mortgage for $625,000.
- On 11/14/2006 they obtained a HELOC for $100,000.
- Total property debt is $725,000.
- Total mortgage equity withdrawal is $436,650 including their down payment.
It is obvious from the photos these people did not spend this money on property improvements. Where did it all go?
We all know this money went to conspicuous consumption and keeping up with the Joneses just like it did for everyone else. Do you want to see them get a principal reduction to pay for it?
Irvine Home Address … 17 CARRIAGE Dr Irvine, CA 92602
Resale Home Price … $715,000
Home Purchase Price … $348,500
Home Purchase Date …. 6/30/1999
Net Gain (Loss) ………. $323,600
Percent Change ………. 105.2%
Annual Appreciation … 6.8%
Cost of Ownership
$715,000 ………. Asking Price
$143,000 ………. 20% Down Conventional
5.11% …………… Mortgage Interest Rate
$572,000 ………. 30-Year Mortgage
$149,907 ………. Income Requirement
$3,109 ………. Monthly Mortgage Payment
$620 ………. Property Tax
$50 ………. Special Taxes and Levies (Mello Roos)
$60 ………. Homeowners Insurance
$0 ………. Homeowners Association Fees
$3,838 ………. Monthly Cash Outlays
-$764 ………. Tax Savings (% of Interest and Property Tax)
-$673 ………. Equity Hidden in Payment
$287 ………. Lost Income to Down Payment (net of taxes)
$89 ………. Maintenance and Replacement Reserves
$2,777 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$7,150 ………. Furnishing and Move In @1%
$7,150 ………. Closing Costs @1%
$5,720 ………… Interest Points @1% of Loan
$143,000 ………. Down Payment
$163,020 ………. Total Cash Costs
$42,500 ………… Emergency Cash Reserves
$205,520 ………. Total Savings Needed
Baths: 2 full 1 part baths
Home size: 2,250 sq ft
($318 / sq ft)
Lot Size: 4,912 sq ft
Year Built: 1999
Days on Market: 4
MLS Number: P727630
Property Type: Single Family, Residential
Community: West Irvine
According to the listing agent, this listing may be a pre-foreclosure or short sale.
This beautiful Fieldstone home, tucked nicely away at the end of a long driveway, has a really functional floorplan with a big living room, a great family room with built-in bookcases that opens directly into the kitchen with center island, and a private, peaceful backyard. Upstairs bedrooms are roomy, and the vast master bedroom has a bathroom with double sinks, separate tub & shower, and a HUGE walk-in closet. One of the upstairs bedrooms has a giant alcove perfect as a retreat or home office. Even the walk-in pantry located off the kitchen is really big! Located in an award-winning school district, and with NO association dues, this happy home will be the site of many great neighborhood parties for years to come!
I get the impression that the man of the house was not responsible for its decoration….
I want to thank my wife for not making me sleep in a room like that one.
BTW, I highly recommend reading Squatting Newport Coast Style, the post from Saturday. It will make your blood boil:
- $2,500,000+ in HELOC abuse.
- Delusional seller who has chased the market down more than 50%.
- Gaming the system to squat in luxury for a year and a half.