The Future of Foreclosures

The Perfect Storm...again?

Greg and I have been speaking publicly for the last few months about a few factors affecting the near future of the housing market. Today, MSNBC picked up an AP story which I linked to below.

Based on our experiences, observations, many anecdotal stories and a recent informal and off-the-record conversation with a Senior Vice President of a major national bank (which received significant TARP funds), we began putting together our vision of what to expect next.

Almost everyone we have spoken to either is in the midst of or knows someone who is trying to get their mortgage modified. We have met only one person who has successfully received a "permanent" loan modification. Of the over half-million modification applications in process at the major mortgage lender mentioned earlier, the bank has "permanently" modified only 98 loans. NINETY EIGHT....nationwide, only 98 loans. Tens of thousands have been granted a "trial period" of between three to six months, but these are not permanent. In order for them to become permanent, the borrower must complete the trial period with all payments made on time, then, at the end of the trial period, RE-APPLY for the modification based on updated and current borrower information. At that point, most applicants cannot qualify. The loan is then immediately declared in default and the foreclosure proceedings begin. Our source at this particular bank admitted to us that the bank has no intention of modifying any more loans than is absolutely necessary in order to keep the Feds off their back and that by using the "Trial Period", the bank can at least get some payments on the account and delay moving the asset into the "bad asset" pile.

We have spoken to hundreds of people who have looked at the current market, the forecasts, what has happened in their neighborhood and the values of the surrounding homes and have made a complete business decision to walk away from the property. Each has cited the same set of factors in their decision: Their lenders unwillingness to modify their loan, the drastic drop in values in their neighborhood, the strictly financial outlook of owing more than double what their neighbor owes and what that will mean for years to come for re-sale and, in many cases, what the lower home prices have done to their neighborhood in terms of appearance and overall enjoyability. These borrowers made a decision that a foreclosure on their credit record and possible bankruptcy, depending upon their circumstances, would be less devastating than staying, even though they could afford the monthly payments. This has recently been dubbed "Strategic Default".

"Shadow Inventory" was a term Greg coined over a year ago and has since been picked up by almost everyone. The term was originally meant to describe the tens or hundreds of thousands of residential properties which had been abandoned or had borrowers who had not made a payment for months or even over a year but were not yet foreclosed upon. Again, we thank our source at that bank mentioned above for validating what we had already assumed: by not foreclosing, or an many cases not even filing a notice default, the bank can keep the number of bad assets "reported" lower than the "real" number should they foreclose on every property meeting the requirements. This artificially inflates the books, artificially lowers the foreclosure rate and allows then bank to boast big gains when, in the real world, they would still be posting record-shattering losses. We can now add the tens of thousands of foreclosed and bank-owned properties which are not yet listed and on the market. Again, this simply keeps available, "for sale" inventory artificially low, competition between their own assets artificially low and keeps the sales numbers artificially high.

Finally, the fantastic government incentives for buyers has helped increase home sales. This worked as it was meant to. First time home buyers have been able to finally get into a home of their own. With exceptionally tight underwriting standards for these loans, these home owners should be in a good position to actually be able to afford the home they just bought.

Now, we can add in a factor that began only a few months ago: higher income borrowers in higher priced homes running out of the savings that has kept them going for the last year or so. These otherwise well-qualified, former grade AA borrowers are making the same business decisions others are making and walking away from their second or vacation homes or sizing down to a smaller home, and, unable to sell their larger and much more expensive home, deciding to walk away from that loan. This has moved the price point of the foreclosures up significantly and is leading to a new round of foreclosures previously not anticipated.

Bottom line: Unwillingness by banks to modify existing loans, strategic default by borrowers, shadow inventory, foreclosures creeping in to higher-income borrowers and the uncertainty of the future of government incentives for home buyers have all factored together for another inevitable perfect storm - another dip, another round of foreclosures, possibly even broader and deeper than what we have already seen.

What does this mean for a potential buyer? Keep your eyes open, stay aware and be ready with as much cash as possible to pounce on the home you want when it finally becomes available.

Look for our next quick article on how to structure your offer on a bank-owned property to make it as attractive as possible to the seller.