Asymmetrical Information

Not mention that people often don't really know if their home has dropped 20% in value until they try to sell it. And, of course, a large fraction of mortgage-holders whose homes have decline in value by 20%, *still* have a lot of positive equity in their homes because they didn't buy at the top of the market. Silly stuff.

Jim Cramer did sound nuts saying that 100% of a certain category would default. However, he uses the example of a 20% decline, and I think that declines could be much more substantial. For examples, see burbed.com, whose raison d'etre is showcasing slummy Bay area houses priced around 600K or $900 per square foot, ideally with the yard paved over and facing a freeway, or at least in a semi-industrial neighborhood. Likewise, if you look at LA's craigslist and search for Compton houses for sale, it looks like sellers are trying to get 300K-465K. How many Compton homeowners can afford to hang on if they have that kind of mortgage, especially if it's a bad loan that is adjusting steadily upward? If one lives in Compton and has a 400K mortgage, one is almost by definition financially distressed.

Meanwhile, in Rockville, MD in charmed Montgomery County, builders were recently trying to sell new 3 BR condos near the metro (next to last stop on the red line) for 900K. For comparison, you can buy a townhouse in or near Georgetown for that. The builders themselves at some point realized that they were in trouble, and some of the condos were turned into rentals.

We're looking to buy a house next year (either Texas or MD), so I'm following this very closely on thehousingbubbleblog.com.

According to Cramer we're all supposed to be selling our houses now and putting the money into Google. Hmmm... maybe not such a bad idea considering this record http://www.stocktagger.com/2007/07/jim-cramer-google-inc-goog-track-record.html

". . . house is the one thing that's fungible. It's smart to walk away... If your home declines 20% in value, it's really important to walk away from it."

I think Cramer has forgotten that most people, while often taking on more mortgage than they should, still view their houses as, you know, homes.

Of course, since the housing market, via its increasingly baroque and clever financing methods, borrowed a huge amount of demand from the future to prop itself up, we're destined to have it move sideways (on balance) for several years. Given that, it's more important to keep the economy moving and let people slowly get out from under their ill-advised mortgages, than to try to artificially prop up the housing market again with easy cash (Greenspan during the stock market bubble-style).

I think Cramer has forgotten that most people, while often taking on more mortgage than they should, still view their houses as, you know, homes.

Yeah. I could possibly see a bit of this with second homes and homes bought as an investment ("because the housing market always goes up"), and with mortgages with balloon payments where the buyer intended to sell before the payments ballooned. But how large a percentage of the market can that be?

Yeah. I could possibly see a bit of this with second homes and homes bought as an investment ("because the housing market always goes up"), and with mortgages with balloon payments where the buyer intended to sell before the payments ballooned. But how large a percentage of the market can that be?

He's GOT to be thinking that way, or else he's been smoking dandelion blossoms soaked in laquer thinner. Walking away from a primary home not only forfeits any accumulated equity in the home, it also ensures you won't be buying another home for quite some time (well, maybe if you show up at a HUD auction on a slow day). So, you need a place to live. Presumably, that means transferring your life into a rental, where you can dump the larger portion of a monthly mortgage payment into something which you will never own, nor accumulate any equity whatsoever.

Wonder how Cramer's type would fare in an East-Meets-Midwest remake of The Simple Life. Might even make Le Paris look like the smart one.

A few points:

1. There may be no equity if the home equity has been tapped, and the value of the home has fallen or is stagnating.

2. In many areas, you can rent for half the cost of owning.

3. In economically stagnating areas like Michigan, there is no guarantee that the value of the house will even rise at the same pace as inflation.

4. Thanks to the ever-growing supply of condos, there is going to be abundant "affordable housing" for the foreseeable future.

5. As I mentioned earlier, thehousingbubbleblog.com is very good for this sort of thing. Also, if you listen to Dave Ramsey, a lot of his financially distressed callers got that way thanks to house purchases.

Lived in Dallas during the 80's when the bottom dropped out.

Things got really ugly, many people did actually walk away, piled what they could in their pick-ups and leave for greener pastures.

Given the length of time it took for that market to recover, I would say that those who did probably were better off that those who stayed and tuffed it out.

Amy_P: I'm curious -- doesn't defaulting on a mortgage also make it hard to rent, after they do the credit check?

The tin-foil hat wearing Housing Bubble blog folk point out that it is possible to stop mortgage payments, lay up money for deposits, and apply for the new apartment while credit is still relatively good. Voila, unethical as heck but problem solved!

Jane,

Normal people default on there loans when that tickler ARM at 2% adjust to 7% and there payment goes from $2400/month to over $5000. Especially when they got stated income loans for 105% of value. There is no equity. If you bought a house since 2003 in any of the bubble areas you are probably underwater wrt to your mortage (in negative equity area). Bubble areas include Florida, California, Las Vegas, Phoenix, Dc-Boston corredor. Basically anywhere where the median house cost more than 2.5-3.5 times the median family income. If your making $50K you should not be buying a $500K house/condo.

In a lot of places you can rent for 50% or less than the cost to buy a similar place. Nows the time to rent and invest the difference. Buying is not a good idea and probably won't be until '09 or '10.

have a fun vacation!

Amy_P: Interesting. I suppose you can't be evicted as long as you pay the rent, even if your credit plummets.

Actually, buffpilot just reminded me of something I can't seem to get a firm answer on: aren't a lot of lenders horribly bastardizing the term "interest rate"? I thought that that term meant "rate at which the debt accumulates". That means if, e.g.

-You take out a loan for $100,000
-You're obligated to pay $2,000 the first year
-The debt at the end of the first year is $108,000

The interest rate on the loan should be reported as 10%, NOT 2%, and still lenders are allowed to claim that 2% is the interest rate? What gives?

I'm assuming that the 2/28s he's referring to are the 2005 vintage, which wouldn't have any accumulated equity built into them.

And if things get bad enough, wouldn't lenders (i.e. sellers) be a little forgiving on credit checks if they're dumping all the properties they've foreclosed on?

Still, 100%? I don't understand what's he's thinking there.

Person,

I believe that's called negative amortization. There are also some "pick your payment!" loans, which probably feature negative amortization in the lower payment ranges.

Does anybody learn this stuff in school? I did an academic track in high school, and we never learned the math behind this stuff. I still don't quite get how amortization works.

The interest rate on the loan should be reported as 10%, NOT 2%, and still lenders are allowed to claim that 2% is the interest rate? What gives?

2% is not the interest rate, but the payment rate. The interest rate is higher. However, mortgage companies advertising these types of deferred interest (negative amortization) loans often advertise the payment rates in big numbers. Yes, it is considered misleading.

It's a decent option for people who expect to become wealthier in the future but want to get the house now, or (of course) if the housing market is super hot. It is a gamble, though, and a really bad idea for some people.

OTOH, while one's credit score going down by 200 points is never good, a deed in lieu of foreclosure may still yet be preferable to struggling along in a mortgage too big in a house too big in some situations. Cramer's off his rocker suggesting that it forms such a percentage of the market, but there can come a point where it makes pure financial sense.

Seems to me he's talking about walking away with a 20% drop in price AND a 2/28 mortgage. Given that 2/28's are almost all low-down or no-down mortgages, folks who walk away aren't losing much and are probably freeing themselves from the bondage of a mortgage they can't get out of.

One of the uglier aspects of the housing meltdown, IMHO. No-down or 3%-down is awesome if you're buying with little savings. But really, one's stake in the property is small. Compare that with a 20% down-payment and the homeowner has lost real savings by walking away. I've had both kinds of loans and I believe there's a difference.

I think Cramer's touching on how a house becomes a complete-and-total-nightmare with a resetting 2/28 in a down market.

In Cramer's world, the lenders will never come after you. In the real world, I don't think it's that easy. Bankrupcy is the only way to discharge the obligation, and it will mess you up for a long time. Walk away? As soon as you accumulate enough worth taking, the lender will come along with his judgement and take it.

This is the bear's equivalent of irrational exuberance. A book titled Dow 3,600 will be along any day now.

John_Thacker: The problem is that in cases like that, it would specifically call the 2% the "interest rate", *not* the "payment rate". I saw this on some loan ads on websites as well, and in the stories about subprime loans.

Try it yourself: any time you see an ad quoting an "interest rate" under that on treasuries, click on the link, read the fine print, and calculate the true interest rate.

Amy_P: I know what negative amortization is. That wasn't the question. The question was, is it fraudulent to call the payment rate the "interest rate", when in reality the debt is accumulating faster, and why are these not prosecuted as fraud?

Person,

I expect that you would know, but not everybody does. I would also wonder about the legality of those rather deceptive mortgage ads showing the dancing people hopping about.

MarkD,

One other thing I've heard is that even if the bank authorizes a short sale (accepting less than the value of the loan), the forgiven loan is treated as income, and the former homeowner has to pay taxes on it.

I suppose you can't be evicted as long as you pay the rent

Well, not for the duration of the lease contract, anyway, provided you aren't in violation of other terms. If it's a typical one-year lease, then you've got the remainder of the year to change the locks, oil the shotgun, and start reading up on Squatting for Dummies.

"One other thing I've heard is that even if the bank authorizes a short sale (accepting less than the value of the loan), the forgiven loan is treated as income, and the former homeowner has to pay taxes on it."

Wouldn't that just be an offset against the losses you could claim from selling the house? (Unless you're a total idiot who found an equally stupid banker, so your principal exceeds the original price of the house.)

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