Its Murky Underwater

The definition of being underwater on a property essentially means that the current value is less than the original mortgage. According to Zillow, industry practice is to exclude principal payments and equity extraction from the data analysis. So someone may be technically underwater, but the actual amount due on the mortgage is really less then the amount due. Or someone may not be technically underwater, but since the equity has been extracted through a HELOC over the years they really do owe more than the property is worth.


There is also the other pre-qualifiers for underwaters, commonly the data is only for people that currently have mortgages on their property. Since, supposedly, 32% of all properties do not, yes NOT, have mortgages they are not included in the data. Also, the data is usually only for owner-occupied premises with 1 to 3 housing units on the property. So deducting another 52,556,000 million homes which include vacant properties, seasonal homes, rental units, new construction, and mobile homes. The final pool of possible underwater is 46,461,000 - all the owner-occupied properties that actually have mortgages on them. This is 46,461,000 out of 128,203,000 housing units. Which is only 36% of all the housing units in the first place.

Next is the Zillow press release regarding underwaters we will through in a few paragraphs about foreclosures and short sales as well. Lets take a look at the widely cited release -

Foreclosures(4) made up nearly one in five (19.9 percent) of all transactions in 2008. The hard-hit Central Valley in California continued to lead the nation in foreclosures, as more than half of all sales in the Madera, Merced and Stockton metropolitan statistical areas (MSAs) were foreclosures. The New York City metro area and the Grand Junction, Colo., had the lowest rates of foreclosure in the country (both at 3.9 percent).

For the first time, Zillow has also calculated short sales(5). Across the country, 10.9 percent of all real estate transactions in 2008 were short sales. The Lincoln, Neb., MSA led the country in the rate of short sales, with 14.1 percent of all transactions. In the San Jose, Santa Rosa and Santa Cruz, Calif., MSAs, short sales made up more than 11 percent of all transactions.

As home values declined through 2008, more American homeowners have become underwater on their mortgages. At the end of the year, one in six (17.6 percent) of all homeowners had negative equity(6). This number rose from the end of the third quarter, when one in seven (14.3 percent) homeowners was underwater.

As we noted in an earlier post about the possible differences of what "all" may mean in this analysis here -

Also, the 17.6 percent underwater hopefully the are just for the 68% owner occupied ones that actually have mortgages. If 17.6% of all houses (including rentals) are underwater that means approximately 19,481,792 properties are underwater. If it is just for all the owner-occupied properties the would be about 13,313,872. And if it is owner occupied with a mortgages the number underwater would be 8,177,136. None of these numbers are good, but there is a huge difference between almost 20 million properties being underwater and just over 8 million.

Then through a Housing Wire post titled One in Six Borrowers Underwater on Mortgage, Zillow Says the following -

But by far, the overwhelming picture painted for 2008 was one to forget for housing. And if Zillow’s estimates of the number of underwater borrowers are correct — First American CoreLogic has estimated that 7.6 million U.S. households were underwater on their mortgages as of Oct. of last year — we have much further to go to complete a correction in many of the nation’s key housing markets.

We can see the number given from an American Core Logic report published last October, the 8 million mark give or take sounds correct. The problem is the vague method used to describe these numbers.

Finally there are two ways to report this 8.177 million properties underwater - the headline grabbing method of 17.6 percent underwater!!! Or a lower percent using all owner occupied but less grabby - 10.8 percent. We do not want to include the rental units - since unfortunately there seems to be no reliable statistics regarding the financial status of 35,045,000 housing units. Which could easily be the most alarming part of this whole story!

The Case of the Missing Equity

Now that the bubble has burst and housing prices are in free fall, where did all that equity go? You now, the equity that helped fuel our patriotic consumption. According to Bloomberg in the article titled U.S. Property Owners Lost $3.3 Trillion in Home Value Last Year. No wonder equity withdrawals are limited, there is no equity left. Lets take a look -

The U.S. housing market lost $3.3 trillion in value last year and almost one in six owners with mortgages owed more than their homes were worth as the economy went into recession, Zillow.com said.

The median estimated home price declined 11.6 percent in 2008 to $192,119 and homeowners lost $1.4 trillion in value in the fourth quarter alone, the Seattle-based real estate data service said in a report today.

“It’s like a runaway train gaining momentum,” Stan Humphries, Zillow’s vice president of data and analytics, said in an interview. “It’s difficult to say when we’ll see a bottom to the housing market.”

...
About $6.1 trillion of value has been lost since the housing market peaked in the second quarter of 2006 and last year’s decline was almost triple the $1.3 trillion lost in 2007, Zillow said.

...
The number of homeowners with negative equity, or those who owed more on their homes than the property was worth, rose to 17.6 percent from 14.3 percent in the third quarter, Zillow said. The company began its quarterly reports in 2006.

According to the article, for the 4th quarter median prices were down 6.2% for the New York-Northern New Jersey-Long Island area. The new median price for this region is $395,478. While the numbers are somewhat bad, the financial fall out from Wall Street problems will not be felt for some time.

Also, the 17.6 percent underwater hopefully the are just for the 68% owner occupied ones that actually have mortgages. If 17.6% of all houses (including rentals) are underwater that means approximately 19,481,792 properties are underwater. If it is just for all the owner-occupied properties the would be about 13,313,872. And if it is owner occupied with a mortgages the number underwater would be 8,177,136. None of these numbers are good, but there is a huge difference between almost 20 million properties being underwater and just over 8 million.

Warning - Realtors Giving Financial Advice

Our previous post warned about getting financial advice from a Realtor. We noted that to be a realtor in New Jersey you did not need much other than an high school diploma (or GED), taking a 75 hour course, passing an exam, and to find a sponsor to hire you. Many places offer the course in a 12 day program. Pretty scary when you realize that this is all the requirement needed. From the NJ Reatlor's themselves, less than 1 in 2 reatlors has a Bachelors Degree! Directly from them -

The report found that the typical REALTOR ® has been in business for 10 years, compared to the national median of eight years. Nearly half of all REALTORS® in New Jersey have a bachelor's degree or higher (45 percent).

If all Realtor were doing was selling properties that would be one thing. But thinking this background is strong enough to give out financial advice about one of the biggest financial decisions most people make in their lifetimes is scary. Although we are not anti-realtor, we are against real estate agents giving financial advice when they have no background or qualifications to do so! This ought to be against the law! Losing one's license at the very least. Being able to sell a product does not give one the understanding or knowledge to dispense financial advice! We wonder how many realtors even understand half of the mortgage products out there? We have talked to post-graduate degree professionals that get confused about some of the products out there.

Finally, aside from "Real Estate Math" portion of the class what other financial tools are taught in the 75 course? And what is real estate math anyways? Learning how to compute commissions? Or other real estate math, like the wonderful financial advice "don't look at the full purchase price, just look at what your monthly payments will be." How did that work for the ARM and Option ARM holders? Not so good...

Foreclosure and Short Sales Impact on the FICO Score

Here are the FICO issues regarding walking away, foreclosures, and short sales in New Jersey. The FICO results are not as straight forward as you may think. The lenders have alot of latitude about what they report and how they classify it. Short sales may harm your credit score as bad as a foreclosure. With all the other burdens of a short sale, this just adds to the arduous aspect of such a deal. Why bother negotiating if your credit will get hit just the same? Well lets take a look at the FICO side of Sundays Real Estate section with an article titled When you can't go home again -

The biggest problem with walking away from your home and hastening foreclosure is that foreclosure is a huge blight on your credit score: a drop of perhaps 200 or more points on your FICO credit score. (A strong FICO score is around 700 and above.)

Still, if you have already missed a half-dozen or more mortgage payments as Bob and Sharon have, your credit score has probably already taken a big hit.

"Anybody that I talk to who even contemplates walking away from his home, I lay out a number of reasons they shouldn't," said Re/Max real estate agent Sal Poliandro. "A short sale is a way to get you out of your predicament with dignity. It helps the bank get rid of an asset before they come and collect it. When we talk about foreclosure, it's not just a financial thing. As far as credit goes, nothing will ever cost you the same. You're going to have to pay $600 a month for a car, rather than $300 a month. And, with a foreclosure, your name will be in the paper."

And foreclosure can be postponed, Poliandro said, while short sale negotiations are under way.

However, short sales may show up on credit reports as "pre-foreclosure in redemption status," which can seriously hurt the seller's credit score as well.

Craig Watts, public relations director for Fair Isaac Corporation, which created the FICO scoring system, said in an e-mail: "The effect on a FICO score is likely to be very similar for both actions [foreclosure and short sale]. The impact depends on how the lender chooses to report the foreclosure or the short sale to the credit bureaus."

A foreclosure remains on a mortgage-holder's credit report for seven years. But the FICO Web site says, "While a foreclosure is considered a very negative event by your FICO score, it's a common misconception that it will ruin your score for a very long time. In fact, if you keep all of your other credit obligations in good standing, your FICO score can begin to rebound in as little as two years."

Funny that the Re/Max real estate agent is giving foreclosure and financial advice??? And that the FICO guy basically contradicts everything the Re/Max agent says. First thing to note - do not take any financial from a real estate agent, ever. To become a realtor in New Jersey you just need 75 class hours and passing an exam. No college required either - and yet dispensing some of the most important financial advice one may face in their lives. This ought to be illegal!


From the State of New Jersey website -

What are the qualifications for a Real Estate Salespersons license?
To qualify for a Real Estate Salespersons license you must be at least 18 years old, have a high school education or equivalency, complete a 75 hour pre-licensure course at a licensed school and pass the New Jersey examination. After passing the examination, you must apply for a license through a sponsoring Employing Broker within 1 year from the expiration of the school certificate or you must again complete all requirements.

So what have we learned from today -

1. Don't take financial advice from a realtor! You may as well be taking financial advice from the guy next to you at a bar or the woman next to you at the salon. Or maybe the cashier in the grocery store - they are in sales too! And they deal with money all day!!!
   
2. Your credit score may be harmed the same either through foreclosure or short sale.
3. If you choose foreclosure rather than a short sale your name will appear in the paper (in an obscure section that no one will read other than people looking to get a good deal) and this could be devastating!
4. Talk to a lawyer or a financial planner to help with your decision and issues - not a realtor!
5. We need a state-wide push to make realtor's giving financial advice to their clients illegal!
   

Walking Away in New Jersey

Other than the hit to one's credit score walking away sounds so easy. Unfortunately it does not appear to be as easy in New Jersey as it is in other states. Their is a push that a short sale is better than foreclosure, but the process is cumbersome and may have just as big of a negative impact on your credit score. For those underwater their is no solution that is not going to be painful.

Sometimes just getting out heals enough pain to help the owner, soon to be former owner, able to keep getting by. That appears to be the feature story in this Sundays Real Estate section with an article titled When you can't go home again. We were pleasantly surprised to read a positive story regarding someones decision to leave their property. The article has lots of important information for those that New Jerseys' foreclosure mediation program can not or will not help. Lets take a look at the article -

[Sharon] loved the [Oakland] house where she had lived for 30 years and raised her children. But when she and her second husband, Bob, refinanced the house in 2005 to pay college tuitions and buy out Sharon's ex-husband's stake in the home, they unwittingly set off a chain of circumstances that would lead them to abandon their home and move into a rental little more than three years later. It was a $350,000 adjustable-rate, interest-only loan they had applied for over the phone.

"We started getting letters that our mortgage payment was going to increase by $600 a month come January of 2008," said Bob, who along with Sharon asked that their last name not be used. "And that payment was going to keep going up and up and up. I tried to refinance, but there wasn't enough equity to refinance."

...
Bob and Sharon's decision to abandon their home is not so extreme as those who walk away from houses worth less than the mortgage and mail the lender the keys. The couple hasn't made a mortgage payment in eight months or so, but the house is listed for sale, and Bob pays to keep the utilities on. He visits once a week to check on things and shovel snow from the drive and walkways.

...
There are few statistics on how many people abandon homes when they can no longer afford the mortgage payment and the house is worth less — often significantly less — than the mortgage. There are now a number of Web sites offering advice — for a fee — to help struggling mortgage-holders "walk away" from homes that are no longer worth the investment, sites such as youwalkaway.com, walkawayplan.com and mortgagedefaultlegaltrack.com.

...
"People try to talk about the homeowner's ethical decision and moral responsibility [to pay what he owes]," said [Jon Maddux, the CEO of the California-based Web site YouWalkAway.com]. "But banks look at it as a business decision. You have to do what's best for the survival of your family."

...
Bob and Sharon are relieved to be in their new home. They are paying their bills on time, and working to rebuild their credit. Sharon treasures a birdhouse, made by a friend's father, that is a replica of the home where she lived for three decades. Bob worries that there could still be financial repercussions, that someone might come and garnishee part of his paycheck to pay down the unpaid mortgage.

Relieved to be out from under the economic pressures of an ever changing ARM. Happy to have left a home that become a huge burden. Leaving the home and rebuilding the life is a fresh start that can help ease the pain and burden of the foreclosure. We are glad an article featuring people landing on their feet after foreclosure. Note that the morality is only imposed on the borrower side of the transaction. As the morality issue changes, and it will as the numbers of foreclosures rise, there will be little negative impact aside from hurt credit for those leaving an underwater property.

Finally, since the article was so long and involved different aspects of the walking away, foreclosures in the next post we will look at the credit score issue.

Renting From the Bank in Jefferson

One thing interesting that happened during the bubble was that the terms buying and owning became very fluid. One could put no money of their own into something yet still be considered the owner. In these cases it was really the banks and lenders that "owned" the property the "owner" was the one with the name on the title. Many of the cases the "owners" are just returning title of the property through foreclosure.

Some of the buyers are trying to do the right thing and sell the property, but when the property nets less than the current liens who makes up the difference. Will these turn into short sales? Are the "owners" bringing check to closing? How will this price gap be closed? Since we are not the ones involved we may never know who pays what. But from the available data we do know that someone will be losing money on these deals. Which brings us to today's featured example of renting from the bank in Jefferson -

Here is the Property -

The Front of the House.

The Kitchen and Dining Area.

The Living Room.

Here is the property info -

Single Family Property Status: Active County: Morris Year Built: 1965 1 total bedroom(s) 1 total bath(s) 1 total full bath(s) 5 total rooms Style: Ranch Living room Family room

Kitchen Basement Laundry room Bathroom(s) on main floor Bedroom(s) on main floor Master bedroom is Includes: Walk-In Closet Basement is Finished, Full Hardwood floors Fireplace(s) Fireplace features: Family Room, Wood Stove-Freestanding Heating features: Baseboard - Electric,Electric Water Heater,Electric

Cooling features: 1 Unit, Ceiling Fan, Window A/C(s) Exterior construction: Vinyl Siding Roofing: Asphalt Shingle Pets allowed Approximate lot is 44X83 Lot features: Open Lot Approximately 0.08 acre(s) Lot size is less than 1/2 acre Utilities present: Cable TV,Private Sewer, Septic,Shared Well,Electric Service High School: Jefferson

Here are the financials -

• The property was purchased for $180,000 in November 2004.

• The original mortgage on the purchase date was for $180,000 with Flagstar Bank.

• In June 2006 the property was refinanced with an ARM for $169,600 with First National Bank of Arizona.

• A second mortgage was opened the same day in June 2006 for $21,200 also with First National Bank of Arizona.

• The property is currently for sale and listed with a realtor at $189,900.

• Property taxes for 2009 are $3536.86.
  

From the public records we can see that the property was purchased with nothing down - 100% financing. Another thing we can tell is that since the property was purchased through one loan PMI or property mortgage insurance would have been required. During the bubble PMI was often avoided through a piggyback loan. Perhaps that was why the owners refinanced with cash out - taking $10,200 out of a property that they never put any money into. Not a bad deal - making over $10 grand to live in a property for less than 2 years. Imagine a property paying the owner to live there - boy the bubble was great! Asymmetrical compensation of another sort we guess.

Now, just 2-1/2 years after the extraction the the property is for sale. The sale price for $300 less than the mortgages are for. But if the property sells for full asking price and the realtor makes their standard commission, someone will lose $11,694 on the sale. Will that loss come from the owner or the lender?

And what how much will it cost the potential owners to live in this property? Assuming a significant down payment of 20% down which is $37,980 and one received a 30 year fixed qualifying for today's Bankrate.com low of 4.75 rate the potential owners payment of mortgage and taxes would be approximately $1087.23. Also needing to be factored in for a full monthly carrying costs would be insurance and utilities. And believe or not this price is in the ballpark of local Garden Apartment rates, so other than a significant down payment perhaps the monthly carrying costs are not so expensive.