Wednesday, July 1, 2009

Can This Home Be Saved?

Over at Reason Tim Cavanaugh discusses the new Mortgage Metrics Report and comes to the conclusion that more often than not mortgage modifications don’t solve delinquency problems:

That is, lenders are increasingly offering supposedly distressed borrowers substantial reductions in principal and interest payments. (See page 25 to see how rapidly these modifications are becoming much more charitable to the borrowers.) Redefault data track how many of these renegotiated loans end up back in trouble. There's a wide variety in types and degrees of trouble — everything from 30 days' tardiness on payments to completed foreclosures.

But one pattern emerges when you add up all the redefaults per quarter and compare them to the total number of loan modifications: When you take deadbeats and give them a free opportunity to get out of contractual obligations they willingly signed before God and country, a fairly reliable majority of them — and often a fillibuster-proof 60+ percent — end up deadbeating again

As a former loan officer I can tell you that are some very good reasons why loan ‘work outs’ often don’t work out.

First, let’s start with Tim’s use of the word “deadbeat”. Not all people who default on loans are deadbeats. I define a deadbeat as someone who just doesn’t repay debt because that is just their nature. True deadbeats fall in to two main categories. Some people do not repay debt regardless of their ability to pay. It simply isn’t a priority to them even when the debt they are not paying is for the roof over their head. From personal experience I call this type of deadbeat a “Stuff Person.”

The Stuff Person has a nice home and drives a new car. They have the latest Iphone and wear label clothes. Game day the gang meets at their house because they have the huge flat screen TV with all the bells and whistles (Note: I‘m talking about games played on the road, stuff people have season tickets for the home games). They never brown bag their lunch and dinner is at the “IN” restaurant several nights a week. Stuff people pay their electric, water, cable, etc., on the day the service has been scheduled to be turned off. Their mortgage, cars and credit cards are all at the highest interest rates allowed by law because of their credit scores and they pay an NSF charge for almost every check they write. But they have stuff. Sooner or later the cards are maxed out, there’s no equity in the house, and the cars are like two years old. If they can do a refi or a modification they use the breathing room to start spending again. Usually they end up in bankruptcy and foreclosure which they pretty much take in stride.

The second type of deadbeat is the “Dreamer”. The dreamer is the well meaning person who buys the house with an interest only loan for the first year or two and then the payment adjusts to include principal as well. Or maybe the mortgage is an ARM with a low teaser rate. Whatever. The point is, they mean to pay it because they assume that between the time of the purchase and the adjustment some miraculous event will occur and everything will work out. Unlike the Stuff Person who sees financial collapse as an opportunity to start over and get new stuff, the Dreamer becomes angry when they find themselves losing their home or car. The Dreamer thinks it is unfair that everything didn’t just workout and they blame everyone but themselves.

The third category of people who end up in default are not deadbeats at all. They did everything right. They don't buy more house than they could afford. They save. They budget. They don’t buy a new car until the old car is on its last legs. When they lose their job or become ill they call their lender right away. They try to work everything out and when they can’t they are upfront with the bank. Sometimes bad things do happen to good people.

The comments on Cavanaugh’s post were interesting. I could spot which posts were from deadbeats and which were not. I could also spot which posts unfairly labeled everyone as deadbeats whether they deserved it or not.

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