The curse of negative home equity
(MIAMI HERALD) Bruce Lamberto’s mortgages are underwater. He sits on his car outside one of his rental properties where he owes more than the property is worth.
She’s one of hundreds of thousands of South Floridians coping with the reality of being underwater on their mortgages—one of the most widespread side effects of the real estate market collapse.
“I get a little angry. I think ‘Man I bought this for $230,000 and for what I’m paying, I could be in a house’,” she said. “But I can’t dwell on it. I mean, what are you going to do?”
As more than $113 billion worth of home equity has vanished from South Florida’s housing market in the past five years, the number of homeowners with mortgages that are larger than the values of their properties has become enormous. More than 300,000 South Florida mortgages—or 43 percent of them—are currently underwater, the highest level in decades, if not ever. That’s about four times the number of homes in foreclosure.
The underwater problem has been a thorn in the side of a housing market plagued with tight credit, record-high foreclosures and high unemployment. It has contributed to a deluge of loan modification requests, pushed up the foreclosure rate and helped revive a once-taboo exit strategy—the strategic default.
It has also brought about untold levels of stress for homeowners who bought or refinanced at the peak of the market and have seen their homes turn into depreciating investments. Because of the current turmoil in the market, many of these owners can’t sell their homes without taking a loss, and most won’t be able to break even for years, or decades.
The implications are profound for a sputtering economy that was once fueled by homeowners tapping into their home equity for kitchen improvements, vacations, new cars, boats and the like. That option doesn’t exist when you are underwater. People feel poor and disinclined to buy when their home has negative equity.
Richard Walsh saw his home start to shed value shortly after he bought the three-bedroom in 2007 for $550,000. Walsh put down 25 percent of the purchase price when he bought the Northeast Miami-Dade home but, based on the market value of the house, just about all of that money has since disappeared.
The 67-year-old retired firefighter says the home is worth about $380,000, but he has never considered walking away.
“When I sign my name to a paper, I’m obligating myself whether I like it or not,” he said in a response to a Miami Herald query.
Walsh reasons that he has benefitted from the rising real estate market over the years—he bought his first home in the 1960s. He also believes history points to an upwardly trending market, and he’d rather wait for the home to appreciate than walk away from a property and neighborhood he likes.
“There’s an old saying: ‘If you don’t like the weather, wait a minute’,” he said. “That’s how I feel about real estate. If you don’t like the market—just wait.”
But in South Florida, where property values have fallen 54.8 percent since 2006, some homes are so deep underwater that the wait could end up lasting decades.
Ulloa, for example, is more than 60 percent underwater. That’s the point at which the average homeowner makes a decision to bolt, according to a 2010 report by the Federal Reserve Board. There’s good reason for that: In a housing market with a 5 percent annual rate of appreciation, it would take more than a decade to climb back up to the purchase price.
But Ulloa said she fears the blow her credit would suffer if she stopped making her payments more than the 12 years it might take for her to recoup her value. Like the majority of the 14 million Americans facing an upside down mortgage, Ulloa has decided to continue paying and is trying to keep her mind off the thousands of dollars in value lost during the bust.
But unlike many other underwater homeowners choosing to stick it out, Ulloa says she doesn’t feel a moral obligation to pay her mortgage, and she doesn’t particularly like the condo. She’s mainly concerned with keeping her credit score unscarred, and avoiding some of the potential pitfalls of default down the road.
“Think about all the bad things that can happen – deficiency judgments, having to pay taxes on [forgiven debt],” she said in a response to a Miami Herald query. “I’ve considered [walking away], but for $300 or $400 extra a month, I guess the costs outweigh the benefits.”
That kind of cost-benefit analysis has become all too common for homeowners in South Florida, where home values are back at the levels they were in 2002.
Increasingly, the benefits of walking away, or opting for a “strategic default,” are starting to tip the scale, said Chae DuPont, a Miami foreclosure defense lawyer who supports the practice.
Those benefits include staying in one’s home rent-free for months or even years, cutting one’s losses on a long-term, unprofitable asset, and, for some, even upgrading to a nicer rental home at a lower monthly price.
The costs of voluntarily defaulting on a mortgage can be considerable. They include serious credit implications that might keep a homeowner from qualifying for a new mortgage or a car loan for years. Then there’s the various consequences of foreclosure, including the possibility of a deficiency judgment, where a bank can garnish wages to recoup its losses.
There’s also the moral component. Homeowners responding to a Miami Herald query said that despite being underwater, they feel morally obligated to fulfill their mortgage contracts.
That sentiment is being challenged by a growing chorus of attorneys, academics and activists.
“That always troubles me because this is not a moral issue,” said DuPont. “This is a business issue. When you represent business clients you understand that there is nothing immoral about breaching a contract. That is why there are default clauses in contracts.”
DuPont has coached dozens of homeowners through the strategic default process, advising them to stay in their homes rent-free as the legal process of foreclosure plays out.
That process now takes an average of 25 months in South Florida, according to Lender Processing Services, a Jacksonville-based mortgage firm.
It takes nearly 15 months of delinquency before the foreclosure process even begins. Then foreclosure cases linger in courts for an average of 10 months, often much longer if the homeowner has a lawyer.
With allegations of “robo-signing” and lost mortgage documents plaguing banks in foreclosure court, it’s taking longer for lenders to take back homes, and foreclosure defense lawyers are recruiting new clients by promising them months of rent-free living.
According to a recent market report from credit reporting agency Experian, a growing number of homeowners are choosing the voluntary default option. About a quarter of Florida’s defaulting mortgages are strategic, and today there are 50 times as many voluntary defaults as five years ago, the report found. Experian described strategic defaulters as people who abruptly stopped paying their mortgage, while continuing to pay all other bills.
DuPont tells her clients that the hit to one’s credit after default is less than most people fear, and with two years of mortgage-free living to save up cash, many of them won’t need new credit for a while.
VantageScore Solutions, a credit scoring firm, estimates that missing mortgage payments and falling into foreclosure reduces the average credit score by about 21 percent. For example, someone with an average credit score of 690 might see that score dip by 150 points or so to 545, disqualifying him from the best credit cards and auto loans, and possibly hurting job prospects.
But other institutions are getting tougher on strategic defaulters – Fannie Mae recently announced it would ban strategic defaulters from getting new loans for seven years and some banks have threatened mortgage-abandoners with deficiency judgments. In the state of Florida, banks have up to five years after a foreclosure to sue the homeowner for the difference between the outstanding mortgage and whatever is generated at a foreclosure auction.
DuPont tells her clients – about 90 percent of whom are strategic defaulters – to try and sell their homes for less than the amount owed on the mortgage in a transaction known as a short sale. If the bank accepts the sale, it usually waives the right to pursue a deficiency judgment, she said. Also, short sales are typically less damaging to the homeowner’s credit than a full-blown foreclosure.
Short sales made up about 20 percent of South Florida existing home sales in 2010, and nearly half of all sellers took a loss last year, according to data from real estate research firm Zillow.
Bruce Lamberto, who owns three underwater properties in Miami-Dade County, said he has considered all of the available exit options, but ultimately decided to stick it out and make the payments.
“If you walk away, you have no options, and no bank will lend to you” in the future, he said. “That’s one of the reasons I’ve been doing everything I can to make sure I don’t miss a payment.”
It hasn’t been easy. Lamberto, who works for the city of Miami Beach, has renters living in some of his properties, and the rent doesn’t cover the mortgages. Regularly, he has take money from one income property to pay the mortgage on one of the others, he said.
He’s barely hanging on to a $290,000 home he bought in 2005 that has since shed about $100,000 of its worth.
“That one’s really underwater,” he said. “But I’m the kind of guy that’s been brought up – you pay your bills.”
This article includes comments from members of HeraldSource, part of the Public Insight Network. To learn more about the network or to join, visit MiamiHerald.com/insight.