Education >> Home Ownership

Why All the Hubbub?

A new report says that nearly one in four homeowners owe more on their home loans than their homes are worth, a statistic that has many wondering if another bout of foreclosures is about to occur.

Frankly, we don’t consider this news to be worrisome.

First of all, one in four (22.6% to be precise, according to First American CoreLogic) is not all that many. Replace the word home with auto and you’d strike a very different tone: Virtually everyone who has a car loan owes more than the car is worth — we all know that the vehicle’s value falls 20% to 30% the moment you drive off the dealer’s lot. Even though 100 out of 100 — not merely 22.6 out of 100 — of automobile owners who finance their car are underwater, that statistic doesn’t stop anyone from buying a car.

So why are homeowners upset when car owners aren’t? The reason, of course, is that nobody buys a car for investment reasons (except collectors, but let’s not go there). Instead, we buy cars for lifestyle reasons. We need to get ourselves to work and our kids to school, not to mention the myriad other reasons we need a car or truck. Some of us care only about getting there, while others want to arrive in style. Still others want to go as cheaply or safely as possible. But nobody thinks that they’re buying an investment. Rather, we know that we’re buying transportation.

Most of us use the same approach when buying a house. We didn’t buy the condo, townhouse or SFR (single family residence) because we thought it would make us rich. Instead, we bought it because we wanted a home — a place to call our own, where we could raise a family that’s convenient to work, school, church and shops (and sometimes even relatives). And we want all that as affordably as possible while minimizing the risk that someone else (read: a landlord) might interfere.

History has convinced us that houses often grow in value, which is terrific. But the value might decline as well, and that’s okay too. After all, you bought the property to live in for a long time, not to make a buck. As long as you can afford the monthly costs of living there, the fact that your house has fallen in value is not an issue — any more than the fact that your car isn’t worth what it once was.

Even if the house has fallen in value, it’s likely still worth more than the price you paid for it, assuming you bought it five or more years ago.

And this brings us back to CoreLogic’s data. A close examination of the 22.6% of households that owe more than their home is worth (that’s 11 million homes) reveals that these borrowers have a lot in common.

For instance, more than half of them (57%) are concentrated in just five states: Nevada (where 65% of all mortgage loans are underwater), Arizona (48%), Florida (45%), Michigan (37%) and California (35%). With the exception of Michigan, which has been hurt by the depressed auto industry, these are the states that experienced the largest increases in real estate prices during the boom years of 2000 to 2006.

Second, the borrowers who are underwater are generally people who obtained their homes (and their loans) between 2005 and 2008 — at the top of the real estate bubble. Today, 40% of such borrowers have negative home equity. (Indeed, Nevada, Arizona, Florida and California experienced huge booms in home construction this decade: Permits for residential construction in this period rose 72% in Florida, 45% in Arizona, 40% in California and 32% in Nevada, according to the U.S. Census Bureau.)

Finally, underwater borrowers were most likely those who obtained an adjustable-rate mortgage (ARM) and bought a less expensive property.

Add it all up and you get a clear picture of the people who owe more than their properties are worth: They are speculators who bought homes at the top of the market, making small down payments to qualify for low-interest rate loans in an effort to buy cheap housing in the hottest markets in the country. Who are these people?

In a word, investors. Not homeowners. Many of these properties, perhaps even the majority, are investor-owned rentals, not owner-occupied homes. Dismayed by recent memories of the dot-com’s burst bubble and awed by recent jumps in real estate, many people seeking quick gains tried to cash in. Today, with prices down, jobs lost and marriages strained, many of these landlord-investors have found themselves in a pickle.

It’s a problem for them. And their problem has spread to us — because our homes’ values have fallen along with theirs. But we’re in better shape, you and I, because we want to continue living in our homes and we can still afford to do so. Thus our homes are not likely to be underwater and, even if they are, that fact is not terribly relevant, since we have no intention, desire or plans to move anytime soon.

The message, then, to those who are underwater is simple: Suck it up and keep making your payments until you’re able to refinance or find a buyer.

But not everyone believes that this is the correct advice. Brent White, a University of Arizona law school professor and the author of a paper titled “Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis,” argues that those who are underwater should walk away from their mortgages. Since it will be years before these houses return to their prior values, he says, upside-down homeowners should engage in a “strategic default:” Buy now the things you’d normally buy with credit over the next few years, such as a car or another house. Then default, letting the lender take your house. Your credit record will be damaged for years, but it won’t matter, since you won’t have the need to apply for credit, he says.

Fortunately, most Americans seem to disagree with this attorney. A 2009 survey by professors at Northwestern University, the University of Chicago and the European University Institute found that 81% of people think that it is morally wrong to walk away from a house when the homeowner can afford to pay the mortgage. The researchers estimate that 26% of existing defaults are strategic — meaning that they are the deliberate action of someone walking away from the loan even though he or she could afford to keep paying the monthly mortgage.

If there’s a problem in the real estate and mortgage markets these days, it’s not one of economics, but of ethics.

From the February 2010 Inside Personal Finance

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