Mortgage Default Is A Financial Bonanza For Many Homeowners As Foreclosure Crisis Continues

The Office of the Comptroller of the Currency (OCC) painted a gloomy picture for the housing markets with its release of the OCC Mortgage Metrics Report for the third quarter of 2011.  Mortgage delinquencies remain at high levels and foreclosures increased by double digits.

The OCC report covers mortgages serviced by federal savings associations and large national banks which include approximately 62% of all first mortgages with an outstanding principal balance of $5.6 trillion.

Key findings of the report included the following:

1. One out of every eight mortgages (12%) are currently delinquent.  Prior to the relaxation of credit standards that occurred during the housing bubble years, the norm for delinquencies on conforming mortgages was only a fraction of 1%.

2. Foreclosures increased by over 21% during the third quarter as various well intentioned but futile mortgage moratoriums came to an end.  At the end of the third quarter, 1.3 million mortgage loans were in the foreclosure process.  According to Lender Processing Services, the average time for a foreclosure to work its way through the system set a new record of 631 days or almost 2 years.  Keep in mind that this is only the time spent in foreclosure.  Many lenders do not begin the foreclosure process until the loan has been delinquent for 6 to 12 months or longer.

Accordingly, many of the homeowners in the foreclosure process have been living “rent and mortgage free” for 3 years or longer.  Since many of the homeowners being foreclosed upon received their mortgages during the easy lending years when 100% financing  was almost universal, the result has not been “financial hardship” but rather a financial bonanza.

Misguided government efforts to keep homeowners in homes that they cannot afford while at the same time allowing them to enjoy free housing has only prolonged the housing crisis by perpetuating a huge overhang of shadow inventory that delays free market forces from allowing housing prices to bottom out.

3. Massive, expensive and time consuming government programs to “modify” mortgages have basically been a disaster which have extended the housing crisis to the same degree as foreclosure moratoriums.  Since 2008 a total of 2,258,026 mortgages have been modified, resulting in payment reductions of up to 35% or $567 per month.

Those homeowners who made conservative financial decisions, saved for a significant down payment and are making their mortgage payments on time even if it involves financial sacrifice may wonder if the government is being fair.  Perhaps they haven’t heard that the new mantra for improving the economy is to “share the wealth”.   Those debating the proper role of government in the foreclosure crisis should consider the words of Austrian economist F.A. Hayek who said that “There is all the difference in the world between treating people equally and attempting to make them all equal.”

The result of the government’s effort to stabilize housing by modifying mortgages is shown in the OCC chart below and is an unmitigated disaster.  The re-default rates for borrowers 12 months after modification is sky high at almost 40%.  Keeping people in homes that they simply cannot afford makes zero sense.  Incongruously, the government has vowed to redouble its efforts at loan modification under the theory that not enough modifications were implemented.  Expect the expanded version of loan modification to mirror the disastrous results of the original loan mod programs.

A recent study predicts that the foreclosure crisis in not even in the fifth inning yet.  In a report entitled “Lost Ground, 2011” the Center for Responsible Lending says:

As the nation struggles through the fifth year of the foreclosure crisis, there are no signs that the flood of home losses in America will recede anytime soon. Among the findings in this report, Lost Ground,2011, we show that at least 2.7 million households have already lost their homes to foreclosure, and more strikingly, that we are not even halfway through the crisis.

One interesting set of facts in the Lost Ground report that may seem counter intuitive at first is the fact that the largest amount of loan delinquencies and foreclosures have occurred in the highest income levels.

The higher income groups apparently made a rational and rapid decision that default was the best option.  Why continue making a large mortgage payment on a house that is worth considerably less than the mortgage balance?  Does anyone really think that a house purchased for $1 million 5 years ago and now valued at under $400,000 will increase in value by 150% any time soon?

Not specifically addressed in the gloomy report by the Center for Responsible Lending is the potential flood of foreclosures from the 8 million homeowners still hanging on and making payments on homes that are worth far less than the mortgage balance.  Unless housing values and incomes rapidly increase due to a miraculous economic recovery, we are facing a torrential flood of foreclosures as millions of underwater home owners eventually conclude that defaulting is the only financially sound option for getting out of “housing prison”.

More on this topic:

Delaying Foreclosure: Borrowers Keep Homes Without Paying

The ensuing delays are further harming the housing market. People who stay in homes undergoing foreclosure for years often don’t maintain the properties, causing blight and lowering property values in the surrounding neighborhoods, said Dunn.

Then there are the court costs that lenders bear, which will eventually be borne by home buyers as lenders increase their borrowing fees to cover the increased risk, Dunn said.