Posted: 30 Sep 2011 03:30 AM PDT
In a sign of extreme desparation, mortgage insurers and lenders are signing up for a new program that pays borrowers to keep paying their mortgage.
Irvine Home Address ... 28 GREENFIELD Irvine, CA 92614
I have long contended that people who are underwater and paying more than the cost of a comparable rental should strategically default. They are pouring their money down a black hole never to be seen again.
Lenders have tried appealing to morality, but unfortunately for them, strategic default has become common and accepted. Their efforts at appealing to morality have failed.
As families strategically default get out from under their crushing mortgage payments and get to keep living in their houses for two years or more, their friends and acquaintances take notice. As others observe the benefits people obtain from strategic default, they consider it themselves. Once people see someone they know and respect strategically default, all moral compunction vanishes.
Lenders have tried incentivizing loan owners to continue to pay by modifying the terms of the loan to make payments more affordable. Most of these programs provide a temporary benefit and increase the balance owed. Their only measure of success is how many additional payments they can squeeze out of a borrower before they strategically default.
The latest effort to keep loan owners from doing what is in their financial best interest is to dangle a carrot in front of the borrower by offering them direct cash rewards if they continue to pay their loan. This has the same desperate quality as car rebates when the automakers pay people to buy their cars. Perhaps in recognition of how bad things have become that crazy ideas like this are actually being implemented, the American Banker magazine is exploring the ramifications of this loan program.
By Laura Thompson Osuri -- OCT 1, 2011 12:00am EDT
Only a banker would think loan owners should be applauded for pouring money down a rat hole.
The dangling carrot approach. The lender makes a phantom payment to an account the borrower only gets if they pay on the loan until the loan is paid off by sale, refinance or full amortization. For an underwater loan owner, they can't sell, and they can't refinance, so they only way they see this pittance is to keep paying their mortgage for a decade or more until they have enough equity to get out of their property.
No, abdicating lender responsibility and unleashing a Ponzi scheme which dramatically inflated house prices feels unsettingly un-American. Making the bankers eat their losses and bear the consequences of their foolishness feels settlingly just.
I am amazed at the mindset of these bankers. This article was written for their consumption. They really believe that debt is as American as apple pie, and the terms of a promissory note are moral obligations. Perhaps widespread strategic default will get them to reconsider their attitudes and actions, but I doubt it.
Bribery is a very old concept, but I hardly consider it American or desirable.
In the case of underwater homeowners, establishing rewards for on-time payments is a way to replace incentives for a group whose original payment motivation has been lost.
A group whose original payment motivations has been lost? LOL! That is the best euphemism I have read in ages. The group they are talking about was motivated to pay as long as prices were going up and they were given more Ponzi debt to make their payments. Once the HELOC money was not forthcoming, they lost their motivation. ~~ giggles to self ~~
Yes, you can. In fact, it's relatively easy to begrudge your spendthrift neighbor who got this deal because they borrowed themselves into oblivion with reckless HELOC abuse. The prudent get screwed while the imprudent get rewarded.
While the reward will not be enough to make up for the negative equity a homeowner has, Frank Pallotta, a managing partner of Loan Value Group, is confident that that the program, particularly the extra $100 or so up for grabs each month, is enough to make someone rethink a strategic default. "The reward is not intended to put someone 'in the money,' but is more of a 10-year light at the end of tunnel," Pallotta says.
The incentive is too small and too far off in the future to have much effect. Ask any employer who has put together an employee benefit program. If the incentives are not tangible and obtainable in a reasonable period of time, employees do not respond, neither will borrowers.
Mortgage insurers are the ones with the most to gain by buying time. A mortgage insurer is on the hood for the losses from strategic default. As the party assuming this risk, they have the most incentive to pay people to keep paying their mortgages.
Loan Value Group touts that RH Rewards is used in 40 states, offering more than $113 million in rewards covering $1 billion of mortgages. Pallotta says that partner mortgage holders have been able to reduce defaults rate by 50 percent through RH Rewards, with nearly all the invited homeowners agreeing to participate in the program. The default rate among those in the program is "under 5 percent," he says.
This program hasn't been going long enough to know if it really cuts down on strategic default. Further, a 5% default rate is still atrocious. Most borrowers who sign up for this program have likely already decided not to strategically default for whatever reason, so for them, this is just free money for doing what they would have done anyway. Why not sign up?
Yes, one billion out of a 14 trillion dollar market is very small. Also, it would be interesting to know the criteria they used to select their borrowers. I doubt they were picking Las Vegas borrowers who owe $300,000 on their $120,000 homes.
But Alex Edmans, the Wharton finance professor who developed RH Rewards, hopes the program will gain traction with some of the larger banks and mortgage servicers, and that the most distressed homeowners will be moved to the head of the line.
That is exactly what they are doing. If they pay out a few incentives but keep a few extra borrowers paying, they will make more than what they pay out.
"Consumer firms do that all the time with coupon and sales," Karlan notes. "We do not live in a world in which everyone pays the same price for the same service."
There is no justice in finance, and finance professionals are okay with that.
California Housing Finance Agency gets stiffed
The California Housing Finance Agency has been featured on the IHB twice before. The first was when they implemented their $2 billion loan owner welfare California initiative. The second was when they announced they wanted to give money to HELOC abusers. Today we are going to look at one of their bad deals here in Irvine.
This property was purchased on 6/21/2007 for $469,500. The owners used a $455,657 first mortgage and a $14,085 second mortgage to cover the down payment. The buyers put nothing down. The borrowers defaulted, and the California Housing Finance Agency bought paid off the first lender with a $478,584 payment. They are now looking to lose about $150,000 on the liquidation.
Irvine House Address ... 28 GREENFIELD Irvine, CA 92614
What exactly is a starter family? So now we have starter homes for starter families?
Resale Home Price ...... $335,000
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