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‘Underwater’ need not mean foreclosure
NEW YORK – Nov. 5, 2008 – What does being “underwater” in your house really
mean? Probably not that you’re drowning.
The number of underwater homeowners - those who owe more on their mortgages
than their home is now worth - has been growing sharply since 2006 as real-estate
prices have tumbled. By some estimates, between one in six and one in eight
homeowners are in that position, most of them people who bought homes in the
past few years or who put down small or no down payments.
This worries economists and policymakers, since owing more than your home is
worth is the first step toward foreclosure. And it’s a concern to the rest of us
because foreclosures are roiling the financial markets and, closer to home, they
drag down our neighborhoods. (Most people who still have equity, by contrast,
would rather sell their houses at a loss than lose what’s left of their investment.)
In response to concerns about rising foreclosure and delinquency rates, federal
regulators are studying possible new programs aimed at needy homeowners.
There are concerns that such programs could attract a flood of applications from
those who don’t truly need assistance or encourage lenders to push homeowners
into foreclosure. At the same time, lenders such as J.P. Morgan Chase and Bank
of America have committed to working on new loan terms for the most-distressed
homeowners.
But experts who have studied previous sharp housing downturns in Texas,
California, New York and Massachusetts say that being underwater, while
unpleasant, doesn’t lead huge numbers of homeowners to default on their
mortgages and end up in foreclosure.
Christopher L. Foote, Kristopher Gerardi and Paul S. Willen of the Boston
Federal Reserve Bank studied more than 100,000 homeowners who were
underwater in Massachusetts in 1991 and found that just 6.4 percent of them lost
their homes to foreclosure over the next three years, according to a paper
published in the September Journal of Urban Economics. The vast majority of
homeowners simply continued paying as usual because they focused on the
affordability of their payments, not on what they owed, and they believed home
values would eventually recover.
The economists found that homeowners typically lost their homes only after at
least two things happened: Their home values dropped and they either couldn’t
afford the payments or stopped making payments after losing hope that prices
would eventually recover.
Homeowners in California also were more likely than expected to keep paying
during the deep 1990s slump, says Richard Green, director of the Lusk Center for
Real Estate at the University of Southern California. More people turned in their
keys in Ohio and Michigan during the difficult 1980s downturn because they lost
faith in an economic turnaround.
Typically, homeowners fall behind after a job loss, divorce or serious illness. In
the current downturn, foreclosures are higher than in previous cycles because
more homeowners reached beyond their means to buy their homes and simply can’
t keep up the payments. As a result, the Boston economists project that up to 8
percent of underwater Massachusetts homeowners could lose their homes between
now and 2010 - a significant amount, but still not catastrophic.
So what does this all mean for you?
If you have a low-interest fixed-rate loan, you have a valuable asset that might be
hard to replace in the current market, no matter what your home’s value is.
Keeping that mortgage current has some value, even if it means cutting other
household expenses.
In addition, the penalties for defaulting are great. In most cases, walking away
from a mortgage can knock a top credit score down to the cellar, says Ethan
Dornhelm, a senior scientist at Fair Isaac Corp., which sells credit-scoring
formulas to credit bureaus.
A person with a stellar credit score from the high 700s to the top score of 850
would see it drop more than 200 points. A person whose credit score is lower may
see it fall by fewer points, but still end up with a score in the mid 500s. At that
level, reasonably priced new debt, from credit cards to car loans, will be out of
reach. In addition, a default could lead landlords and utilities to require more cash
up front and even affect your job prospects.
If the borrower continues to pay other debts on time, the score will climb
gradually, though it may take three to five years to return to “good” scores, from
the mid-600s and up. Scores of 790 or more – which are rewarded with the lowest
interest rates – won’t be attainable for at least seven years, when the default
blemish finally disappears, Mr. Dornhelm says.
Fannie Mae requires borrowers who have lost their homes to foreclosure to wait
five years before it will accept a loan from them, though borrowers who had
extenuating circumstances, such as an illness or job loss, may requalify within
three years.
What’s more, lenders in most states can go after homeowners for an unpaid
balance on a mortgage. That’s a real risk, especially if you have other assets.
The longer you stay in your house, the better the chances of making it through
this down cycle. Though a return to peak prices may take five or 10 years, some
housing markets may start to bounce back once credit becomes more available.
Meanwhile, you’ll be reducing your mortgage as you make your payments.
Lenders aren’t going to renegotiate just because prices have fallen, but if you
truly can’t afford your payments, contact your mortgage servicer to see if you can
rework your interest rate or work out new payment options. The federal Hope for
Homeowners program, which began Oct. 1, is intended to provide some relief if
lenders will agree to reduce the loan amount to 90 percent of the home’s current
value.
If you can’t get help from your lender, try contacting a credit counselor certified
by the Department of Housing and Urban Development. These counselors have
direct access to lenders’ loss-mitigation departments, which consumers don’t, says
Natalie Lohrenz, counseling administrator for Consumer Credit Counseling
Service of Orange County, Calif. A list of HUD-certified counselors is available
through Hope Now, a consortium of lenders and counselors. (Call 888-995-HOPE
or go to http://www.hopenow.com.)
If you need to sell the property and can’t afford to cover the shortfall, your lender
may agree to a “short sale,” in which you sell at a price below the mortgage
amount. This is a much more complicated transaction to pull off than a regular
home sale, though, and it may hurt your credit score if the lender reports that
you failed to pay off the whole obligation.