The Lender Decision Tree and Limited Resale Inventory

Lenders have limited options for dealing with delinquency. So far lenders are holding current price levels by keeping properties from the market.

Irvine Home Address … 7 Capobella Irvine, CA 92614

Resale Home Price …… $675,000


Ring, ring, ring goes the telephone

The lights are on but there's no-one home

Tick tick tock it's a quarter to two

And I'm done

I'm hangin' up on you

I can't keep on waiting for you

I know that you're still hesitating

Don't cry for me

'cause I'll find my way

You'll wake up one day

But it'll be too late

Madonna — Hung Up

Borrowers are done paying, and their hanging up on lenders. The lenders are still hesitating, waiting for borrowers to pay. Lenders will wake up one day and start the foreclosure process in earnest. Will it be too late?

The Lender Decision Tree

When lenders make loans, they far prefer borrowers to repay those loans; in fact, their entire business plan relies on it. As long as borrowers are current with their payments, lenders are happy and making money. When borrowers don't make their payments, the end result is a distressed sale. If there are enough of these, market prices are reduced dramatically which causes significant lender losses.

Below is the lender decision tree for delinquent borrowers. Today we will explore this diagram in some detail and discuss the ramifications of the decisions lenders make.

Loan Modifications

Once a borrower stops paying on the loan, the first step in the process is to attempt a loan modification. Many borrowers are using this step as a place to game the system for more time in the property. If the loan modification is successful, then the borrower is made current and everyone is happy. Very few loan modfications are successful mostly because it isn't in a borrower's best financial interest to get temporary relief and sustain the huge debt. Loan modifications are the first step in the amend-pretend-extend dance.

Short Sale

The next option is a short sale. This process generally goes nowhere because Banks Refuse to Recognize HELOC and Second Mortgage Losses. To give a sense of scale of this problem, consider this: "Together with Citigroup the banks hold about 42 percent of the $1.1 trillion in second-home liens. Unlike first mortgages, they are typically not bundled and sold off to investors but kept on the banks' books. The biggest home-equity lender in the U.S. is Bank of America, holding some $138 billion in such loans. Wells Fargo has about $123.8 billion of home-equity loans." These loans are all going to go bad, and it will decimate the banking industry when these losses are finally recognized.

Short sales are not going to be the final resolution of this problem for one main reason: many distressed sellers do not bother to attempt a short sale. First, for those with non-recourse loans, they are foolish to attempt a short sale because buried in the terms of the sale is the abandonment of their non-recourse status. Plus, why would they go through the hassle? The magnitude of the loss doesn't impact the borrower, so there is little incentive for them to participate in the short sale process. Once they decide they are not going to sell and obtain any equity, most people stop paying and stop responding to lender inquiries. If borrowers don't care enough about the property to communicate with the bank, they certainly are not going to get involved in a short sale process.

If a short sale does go through, it is still a distressed sale. It is a sale that probably would not be occurring in the market if the borrower were not in distress. These should be inventory added to the organic inventory of people moving for other reasons. One of the side effects of having 11.2 million properties underwater is that about 25% of our organic sales inventory is removed from the market. People are trapped in their homes.

Squatting and shadow inventory

Once loan modifications and short sales have failed, the only options available to lenders are within the foreclosure process. At this point, borrowers are not making payments, and contractually, lenders have the right to force the sale of the property at public auction. Prior to the Great Housing Bubble, it was inconceivable that lenders would allow borrowers to squat in houses once it became obvious they were not going to repay the loan. Now that over 10% of loans in the United States are delinquent, lender are overwhelmed by the volume. And since lenders know that foreclosing on all those people will cause them catastrophic losses on their second-home lien portfolios in addition to crushing home prices, they are choosing not to do anything. More than one-third of all delinquent borrowers have been delinquent for more than a year. Squatters are everywhere.

The reason lenders are allowing widespread squatting are twofold:

  1. Lenders hope that people in this category will cure their loans with a loan modification. Nobody believes this is the cure to the problem, not even the lenders.
  2. The government benefits by having fewer homeless and no rioting in the streets. The twenty-first century's version of squatter's rights is allowing delinquent homeowners to stay in their homes. It prevents Hoovervilles and provides significant economic stimulus through the temporary elimination of housing expenses. Too bad it totally screws renters who don't enjoy such benefits.

Shadow inventory is foreclosure's purgatory. It prepares delinquent borrowers for the singularity of trustee sale.

Pre-Foreclosure Inventory

Once lenders finally serve notice on the squatters, these properties show up as pre-foreclosure inventory and we can see them on Although the amend-pretend-extend dance is primarily keeping people in shadow inventory, a huge number of properties are bottlenecking in pre-foreclosure.

We have been watching the foreclosure market very closely. Ordinarily, very little inventory exists here because once the process is started, it tends to move forward in an orderly process and is resolved in about five months. Not anymore.

I took a survey of properties scheduled for sale during the first four months of 2010. The dancing is evident. Over 50% of scheduled trustee sales are postponed, some of them are postponed many times. Over 25% are cancelled, presumably due to a loan modification. This is the outcome lenders are dancing to obtain. Less than 25% go to auction on any given day with lenders taking 10% to 15% and third parties getting 5% to 10%. It is the postponements that are most telling.

An IHB reader has contacted me about a property that has been scheduled for trustee sale for over six months. Every two weeks, the sale is postponed for another two weeks. The first mortgage on this property has not been paid since 2008, and the borrower is making no effort to pay. The one and only reason for this postponement is because the lender is unwilling to take the loss. This is happening all over, and the postponement numbers above are testament to this phenomenon.

Unfortunately, due to the endless postponements, we have been unable to put any owner-occupants into any foreclosure properties. For any given property, there is a 93% chance that the auction will be postponed, canceled, or sold back to the bank. This makes a nearly impossible environment to work with families. We will let everyone know when this changes, but for now, that is what we are up against in the foreclosure market. The dance goes on for the sake of those cancellations as lenders hope those loan modifications are successful. Most end up re-defaulting and accumulate in shadow inventory or back here on the path to foreclosure.

Keep in mind that these pre-foreclosure inventory numbers are the visible inventory. Shadow inventory is four times as large.

Limited Inventory

On any given day, less than 25% is released to the public. The effect is to restrict local inventories and cause competition among would-be buyers. Ask anyone active in the market today, and they will tell you that the competition is fierce because so little of the MLS inventory can actually transact. The few reasonably priced properties usually offered by lender REO departments get much attention. Buyers often have to bid over ask and accept onerous terms. Many sellers offer at WTF prices nobody can afford, so they are effectively out of the market. Many properties are short sales that linger for months with twenty offers waiting for the second lien holder to accept a loss. When it doesn't happen, the property heads to foreclosure.

The effect of these conditions is to create limited inventory for the lenders to sell their own properties at inflated prices. If inventory is restricted enough, lenders capture the most motivated buyers. That is the way monopolies, oligopolies and cartels operate. Unfortunately, since this is a cartel, and since there is a huge shadow inventory, each cartel member gains advantage over the others by releasing more inventory. Once the administrative roadblocks are removed, we should see more inventory that moves from shadow inventory to visible inventory and finally through foreclosure and on to the market.

Until the spigot of inventory is opened wider, the flow of properties will be slow, prices will remain inflated, and shadow inventory and squatting will continue unabated. The Ponzis inflated house prices with their quest for appreciation income, and now inflated prices are supported by allowing the Ponzis to squat in their castles of debt. What was the Ponzi economy is now the squatter economy.

Doubling the mortgage

Many Irvine home owners doubled their mortgage during the housing bubble. With free money readily available, many took it, and now they are losing their homes.

  • Today's featured property was purchased on 4/21/1999 for $338,000. The owner used a $270,400 first mortgage and a $67,600 down payment.
  • On 10/17/2000 he opened a HELOC for $55,000.
  • On 9/4/2001 he refinanced with a $275,000 first mortgage and a $150,000 HELOC which he didn't use.
  • On 2/1/2002 he refinanced the first mortgage for $286,500.
  • On 10/4/2002 he refinanced with a $400,000 first mortgage and obtained a HELOC of $50,000.
  • On 9/9/2003 he refinanced with Countrywide and got a $408,000 first mortgage and a $50,000 HELOC.
  • On 4/22/2004 he refinanced with a $420,000 first mortgage.
  • On 1/10/2006 he refinanced with a $525,000 Option ARM with a 1% teaser rate and obtained a $100,000 HELOC.
  • Total property debt is $625,000
  • Total mortgage equity withdrawal is $354,600.
  • Total squatting time is at least 18 months.

Foreclosure Record

Recording Date: 08/07/2009

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 03/17/2009

Document Type: Notice of Default

Irvine Home Address … 7 Capobella Irvine, CA 92614

Resale Home Price … $675,000

Home Purchase Price … $338,000

Home Purchase Date …. 4/21/1999

Net Gain (Loss) ………. $296,500

Percent Change ………. 99.7%

Annual Appreciation … 5.9%

Cost of Ownership


$675,000 ………. Asking Price

$135,000 ………. 20% Down Conventional

5.07% …………… Mortgage Interest Rate

$540,000 ………. 30-Year Mortgage

$140,881 ………. Income Requirement

$2,922 ………. Monthly Mortgage Payment

$585 ………. Property Tax

$67 ………. Special Taxes and Levies (Mello Roos)

$56 ………. Homeowners Insurance

$42 ………. Homeowners Association Fees


$3,672 ………. Monthly Cash Outlays

-$717 ………. Tax Savings (% of Interest and Property Tax)

-$640 ………. Equity Hidden in Payment

$268 ………. Lost Income to Down Payment (net of taxes)

$84 ………. Maintenance and Replacement Reserves


$2,667 ………. Monthly Cost of Ownership

Cash Acquisition Demands


$6,750 ………. Furnishing and Move In @1%

$6,750 ………. Closing Costs @1%

$5,400 ………… Interest Points @1% of Loan

$135,000 ………. Down Payment


$153,900 ………. Total Cash Costs

$40,800 ………… Emergency Cash Reserves


$194,700 ………. Total Savings Needed

Property Details for 7 Capobella Irvine, CA 92614


Beds:: 3

Baths:: 0002

Sq. Ft.:: 1908


Lot Size:: 3,586 Sq. Ft.

Property Type:: Single Family Residential Detached

Stories:: 2

Year Built:: 1987

Community:: Biltmore

County:: Orange

On Redfin:: 237 days


As of 15th of March, 2010 this is a short sale. Subject to lender(s) approval of short sale. Upgrade home in Westpark in Irvine CA. This a lovely 2 story home with 3 bedrooms, 2.5 baths and 2 car garage. Tiled floors downstairs, fireplace, kitchen with TV room, refinished cabinets, granite counters and more. Call agent for details.

If you missed the 60 Minutes story on strategic default, you can find it here.

Watch CBS News Videos Online

45 thoughts on “The Lender Decision Tree and Limited Resale Inventory

      1. Swiller

        Mortgage Debt Relief Forgiveness Act is good until 2012…..I didn’t see that in the article…more FEAR mongering to get people to stay in homes they cannot afford to further the debt hamster wheel and back unaffordable housing. I tell people if they are going to default, they need…NEED to do it before 2012.

        At least George Bush did *something* for the little guy. For the people who own other assets or multiple homes…f em, they have the money, let them pay their taxes

  1. winstongator

    The difference b/w a 1% O-A & a 6% payment is $1500/mo. 18k/yr tax free = 24k bonus pre-tax.

    Also, the tax value is $411k at Redfin. I’ve harped on this a lot, but when someone takes out $625k in debt on a home, their tax value should rise to match that. Not a huge difference, but it’s another 2k/yr.

    Also, from Redfin, it seems like this house had a lost decade in the 90’s, declining in price from 1989 to 1999. Mortgage rates were around 10% in ’89, but 7% in ’99. Case-Shiller: LA shows this too. How long till there’s a CSI(ndex) – LA/Miami/Las Vegas show on HGTV?

  2. Planet Reality

    “The effect of these conditions is to create limited inventory for the lenders to sell their own properties at inflated prices.”

    The banks don’t want to sell at a loss, it has nothing to do with “inflated prices”. Prices are now 20-40% down from 5 years ago in most areas.

    The prices the banks are selling at are at fundamental DTI and rental parity except for some premium areas. There are plenty of options for a young family at or below rental parity. People should rejoice at this fact, rather than be miserable over the Irvine premium.

  3. MalibuRenter

    I encountered one of the REOs that wasn’t for sale this weekend. At least two cancelled sales and a complex history. It appears to have been rented back to the prior owner.

    In the part of Malibu where I am looking, more than half of the homes which have actually sold were REOs. Homes in various stages of foreclosure outnumber listings.

    Of the homes where I lived as a renter, one foreclosed in the 1990s, right on schedule. One was foreclosed in Dec 2009, after a cancelled sale and some maneuvering; not sure if the former owner is evicted yet. One is now scheduled for auction after a wild case of refi and HELOC abuse. One went through a normal sale at a profit. One is sitting vacant, but not in foreclosure.

    Oh, and one burned down in a wildfire.

    If the shadow inventory was let loose, it would have a huge effect.

      1. MalibuRenter

        Well, that’s not my part of Malibu, but a 3000sf house with an ocean view in the mountains with a yard should go for $800-900k. Of course, owners are asking 30% above that price, and not selling.

        There are some foreclosures in the neighborhood which have been close to that price.

  4. Geotpf

    If a lender thinks prices will increase in the short term, it is in their best interest to delay foreclosing until that happens, since they can then get more money when they sell it. That may be a reason for some of the delays. Since currently interest rates and inflation are both near zero, waiting has less of an economic cost than if inflation and interest rates were at more typical levels.

  5. irvine_home_owner

    Where are all those insiders who claim the banks aren’t holding properties on purpose? That it’s merely being overrun by the volume and not being able to service it.

    What about the reports that say the big banks are going to let loose their foreclosures by the end of the year? Why would they do that if the slow trickle is working for them?

    Should we really be wary of those ForeclosureRadar maps if those dots are basically meaningless since they don’t really indicate inventory that is going to hit market but rather the talent of banks being able to kick the can?

    Today’s post is a bit conflicting for me. Last week we were told that all the foreclosures will bring the prices down to where they should be but this week’s post says that banks won’t let that happen. So basically… we are in another bubble?

    1. IrvineRenter

      I am not saying the banks won’t allow the inventory to get to market. It is a cartel, and each member gains advantage by cheating. The slow trickle can turn into a flood when lenders lose control. Also, the pressure of millions of squatters living in non-performing assets will weigh heavily on the banks putting further pressure on them to act. But for now, yes, we are in another bubble.

      1. Planet Reality

        This is America. We are in a perma bubble. Make sure you
        are on the right side of the trade.

        I’ve never understood why people care so much about nominal prices. Nominal prices are meaningless.

      2. irvine_home_owner

        “But for now, yes, we are in another bubble.”

        Will I be reading ‘The Great Housing Bubble 2.0’? 🙂

  6. lv2la

    I agree that most desirable communities seem to be in a second, smaller, bubble.
    What is the general consensus about outlying communities? Could they be at or near a bottom?
    We are looking at buying some land in the Castaic area. Prices in Castaic have dropped much more (% wise) than in the more desirable communities of Valencia and Stevenson Ranch. I would still be waiting for those areas but Castaic seems to have dropped much more dramatically and I am thinking the time might be right.
    What are your thoughts on outlying communities such as Castaic?

    1. Misstrial

      Castaic has some series fault-lines running through it.

      These fault-lines run generally parallel to the 5.

      Some serious damage was done to homes and businesses in Castaic and Valencia during the Northridge quake.

      Can you do Canyon Country? Or Agua Dulce?

    2. IrvineRenter

      “What are your thoughts on outlying communities such as Castaic?”

      I will answer your question in more detail in a post for tomorrow, but I am bullish on these outlying areas. Prices are so low in many that they make excellent cashflow investments. Prices may not be going up there any time soon, but when they are that low, you get such a good value for the money that it is a smart buy.

    3. lv2la

      Thanks for the replies. I am not too worried about the commute, I would be worried if I was a 9 to 5er but I own my own business.
      Thanks for the heads up on the fault lines I will definitely check into that.
      Looking forward to your post tomorrow Irvine Renter

  7. kishore

    I was wondering with 8%+ loans over 90 days late in Orange County, why there are so few “notice of defaults”.. I always thought a loan over 90 days late would automatically become a “notice of default”.. Now I know there’s a few steps between being 90 days late and the home receiving a “notice of default”. Thanks for the info.

    1. MalibuRenter

      Denial. If you don’t file the notice, maybe you can continue to pretend these loans are performing.

  8. mike in irvine

    wow…I accidently visited the ‘other’ board today. They have a discussion about irvine prices and refer to IHB. Now I am more confused than ever, should have purchased last year. Why is it that just a few are willing to see the new bubble being created in Irvine…maybe it is not a bubble anymore, just the new reality.

    1. priced_out

      … that’s certainly what people said in the run up of the last bubble.

      Waiting sucks. I hate it.

      I’m losing patience for it, and my wife is wearing me down (“I want a house now”)… the arguments for why prices still have 30% to fall are getting harder to win her over with the longer they stay flat.

      1. matt138


        I remember a graph showing the 90s downturn with the 00s downturn overlaid to show bear market rallies and the # of months since the peak in which they occurred. We look to be right on schedule.

        This. Time. Is. Not. Different. Unless of course we see runaway, and i mean runaway, inflation very soon.

        A study of the 90s downturn psychology would help people realize we should all be bearish on real estate prices.

        Priced_out, the bottom is going to be a knock down, drag out fight between the free market and gov/t&banks;. I would be well capitalized when you finally cave the wife’s “needs” in case you are forced to sell in the near future. still too risky – unless you like throwing money to the wind.

      2. Misstrial

        If your wife is, in this economy, demanding a house, be prepared for further demands once that’s been obtained.

        Next is:

        The “car” (typically MB or BMW or Lexus)
        New furniture
        A new wardrobe
        New makeup collection
        additional or bigger jewelry
        botox and facial fillers

        Read: Stop Acting Rich by Thomas Stanley.


      3. Janzen

        “the arguments for why prices still have 30% to fall are getting harder to win her over with the longer they stay flat.”

        Not to mention, as time goes by and this still hasnt happened, she is trusting my judgment less and less.

        Given the results to date, cant say I blame her…

    2. jb

      This last sentence made me laugh. I took three finance classes at the same time at USC in early 2000. All three profs would pace in front of the classrooms saying the same thing: I don’t understand this stock market at all.

      All of us in the class (including me, sadly) would answer back that the old rules didn’t apply anymore. It was Sales/Price, darn it! Not Price/Earnings! It’s all about growth! Blah, blah, blah…Three months later, those profs had the last laugh.

      1. jb

        Sorry. I should have referenced “Mike in Irvine”. My post wound up much lower than anticipated!

        1. mike in irvine

          The market reminds me of a book i read long ago, Bulls & Bears make money while pigs get slaughtered. The book was about stocks and was not that great but the concept was nice.
          Housing Bulls are making money by buying low or selling high or defaulting and living rent free. Bears will save money by selling at peak and waiting for the bottom….while pigs (renters) like me will get antsy and jump in at the wrong time :). Price would have fallen to reasonable levels if mark to madness had not happened.

  9. priced_out

    At what point is it reasonable for crowds of angry mobs to start evicting these f’in’ squatters ourselves?

    1. matt138

      People like free. You are outnumbered.

      At what point is it reasonable for crowds to start evicting politicians?

      Or do you still think you, the taxpayer, are in their best interest?

      Are you willing to rationalize it as they steal from you to hopelessly delay the inevitable?

  10. lowrydr310

    I stumbled upon this article today (linked through patrick) but I don’t know how much credibility it has because it smells of conspiracy theorist nut-butter however it provides some of insight. If most of it is true, then it helps to explain the current state of economic affairs.

    I honestly can’t picture some secret behind-the-scenes economic master plan being drawn up by some powerful wealthy elite club, but maybe I’m just naive.

    1. matt138

      Bankers want the money. Politicians want the power. If the public allows them to work hand in hand, even better. Put yourself in their shoes. There is no conspiracy.

      They do prefer you pile on debt, pile on work to pay for aforementioned debt, and have no time to educate yourself or do anything about it.

  11. taco shark

    Don’t be mad over what other people are doing. If you can afford a home in Irvine, then buy one if you plan on living in it and “planting roots”. If you can’t afford it, then Corona has nice houses too. Live within your means and you’ll be fine. Remember, don’t use your primary house as an investment, just make sure you can afford it and be happy in it. Life is too short to have more concern than that for you primary residence. If you’re looking for investment property, then Irvine and any other “premium” location is not for you.

    1. Irvine is not different

      No, I must live in Irvine. I will only live in Irvine because of the schools, close proximity to high paying jobs, and pleasant neighborhoods. However Irvine is not different and there should be no premium. I would never live 10 miles away from Irvine but I want to pay the same price as it would cost to live 10-30 miles away. Yes, I know the schools aren’t as good and traffic is horrible but I am not going to pay a premium to live in Irvine. Also don’t expect me to move, I am way too good for that.

  12. lowrydr310

    If Irvine commands too much of a price premium, you could consider buying in Signal Hill!!!

    2/2 1200 square foot condo built in 1983 for $379K. If I’m not mistaken, there was an Irvine condo featured here recently for much less than that. I don’t know about you, but I’d take Irvine over Signal Hill.

    Moral of the story: Don’t blindly assume that Irvine is wildly overpriced and everything else around it is affordable and at rental parity.

    1. Irvine is not different

      Someone once told me I could buy a 3800 sq. ft. brand new house in Victorville for $140K. I laughed in their face.

    2. newbie2008

      Another unit sold for about $100K less. But that $379K unit is special.

      Our current economic situtation is different from the great depression, but also very similar. Squater were kicked out quickly and recourse loans were common. Many skipped town, so collecting was another matter. The stock market crashed and then when up, even with the soup lines expanding. Price were kept up by govt controls and govt sponsored trade cartels/groups. Soup lines have been replaced by food stamps to help maintain food prices, section 8 and squaters have replaced Hoovervilles, private sector unions are essentially impotent, govt subsidized industries and banks are in both situation and driving up stock prices. Questions are Who is the new Hitler to pull the US out of the depression? Who will purchase US arms and in what currency or gold? How much does the currency need to be inflated?

    3. JK

      Listing it and selling it is two different things..that guy is wishing at that price in that community. (Signal Hill)

  13. theyenguy

    Your write The reason lenders are allowing widespread squatting are twofold, actually it is threefold as you and others have writen is FASB 157 which allows lenders to mark their inventory to fantasy rather than to market.

    Soon there is coming a liquidity evaporation in the stock market and bond market places; this will result in economic shock and awe; that is economic dislocation; reducing those willing to pay 4,5,6,7, and 8 times the prevailing household income level. But most of all the Treasury simply is simply going to stop funding the GSEs. Then the oligarchs will lease homes and evict the squatters.

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