More Homeowners Walking Away

It seems I've seen this before.

More and more often, homeowners are just walking away from their mortgages and leaving the bank or other mortgage holder to deal with the property.

If a homeowner has little or no equity in a home and their mortgage payments are ballooning, they have no incentive to stick it out, particularly if they are “upside down” on their mortgage, meaning they owe more than their home is worth. Instead, the homeowner walks away, in effect handing the keys to the mortgage holder and telling them “Good luck!”

"The apparent willingness of borrowers to 'walk away' from mortgage debt," the analysts noted, "has contributed to extraordinary high levels of early default" on loans issued during the 18 months before the mortgage bubble burst. It expects losses to reach 21% of initial loan balances for subprime mortgages issued in 2006 and 26% for those issued in early 2007.

Something very similar occurred during the housing bust back in the early 1990's, though the nation was in a recession, where people were walking away from their mortgages because some housing values had dropped up to 50% and many homeowners had lost their jobs. No one was buying homes and too many homeowners were upside down on their mortgages.

While there isn't a recession this time around (though we are teetering on the brink at the moment), people are still walking away. Most of them have sub-prime mortgages and their payments have gone up to a point where they no longer have the ability to pay them.

A decade ago, most people started off with enough equity in their homes to make foreclosure irrational from a financial standpoint. Consider: If you made a 20% down payment on a house, prices would have to fall by 20%, almost immediately, before you lost all your money and had much incentive to walk away. This scenario was unlikely, particularly since an independent appraiser had assigned a clear value to the home. Foreclosure was remote, absent a personal financial crisis, for another reason: Every month your mortgage payment would reduce your debt and increase your equity, giving you more room for prices to fall.

But over the past few years -- until last spring -- banks and the mortgage-backed securities investors who bought the loans the banks packaged weren't demanding substantial down payments; they were happy with 5% or even nothing down. They also didn't worry about whether or not borrowers were building up equity. "Interest-only" loans, quick mortgage refinancings to cash out any equity, and other inventions often led to just the opposite.

Fortunately my wife and I made a rather substantial down payment for The Manse, which kept our mortgage to a reasonable level at a good fixed rate. Even though we qualified for a much larger mortgage, we didn't want to end up being “house poor”, spending every spare penny on the house and leaving very little for anything else other than food, clothing, and other necessities. We didn't buy too much house. (Frankly, I think we could have gone for something even less expensive, but the missus wanted what she wanted and I didn't protest. Maybe it's just the Yankee frugality in me, making an effort to keep our payments small.)

How many more walk aways will there be? I have a feeling there will be more than there have been over the past two years, and then the trend will reverse as those still holding sub-prime and adjustable rate mortgages will have either given up their homes or refinanced.

Only time will tell.