Underwater? Let's make a deal!
A New Jersey company says it's come up with a way to keep people from defaulting on their underwater mortgages. Jeremy Hobson reports.
Acquiring a mortgage loan. (iStockPhoto.com)
More on Housing - Real Estate
TEXT OF STORY
TESS VIGELAND: The housing crisis was a primary cause of that market meltdown. And in a lot of ways, that sector of the economy hasn't shown much improvement.
This week RealtyTrac said more than 300,000 mortgage holders received a foreclosure notice last month. Even more mortgages holders aren't waiting around for a notice. They're seeing their property value scrape bottom. And they're calculating that maybe it's time to just walk away. Send the keys to the bank, which prompts us to wonder...
Comedian: Let me start with question number one: What were you thinking?
In our continuing look at why we do what we do with our money, today we profile a private industry effort to keep people from walking away by playing "Let's Make a Deal." Marketplace's Jeremy Hobson reports.
"Ain't to proud to beg" sung by the Temptations: I know you wanna leave me, but I refuse to let you go...
Jeremy Hobson: Frank Pallotta has an idea. He's managing partner at Loan Value Group, essentially a consulting firm for lenders. And he thinks banks shouldn't be too proud to beg borrowers to stay in their homes, by offering them a little cash.
Here's how it works: Pallotta finds homeowners who owe much more than their homes are worth, and are therefore, more likely to choose to walk away.
Frank Pallotta: There's approximately 10 million homes that have negative equity, and we think somewhere between five and eight million of those homes are in what we call a "high risk category," meaning that negative equity is enough that the borrower is truly contemplating this option.
But whether a person walks away has to do with more than just the difference between the value of the home and the mortgage, Pallotta says.
Pallotta: We then look at things like income, we look at parts of the country that the borrower is in. The more foreclosures there are in a given square mile or a given radius, the greater the likelihood of strategic default.
So once Loan Value Group identifies the high risk borrower, the question is: How much money would the bank have to pay that person to get them to keep paying their mortgage? Under Pallotta's plan, it comes in the form of cash when the mortgage is paid off or the house is sold.
Pallotta: The reward size is really designed to have the borrower feel as though, one, he's got skin in the game again. Second, that that equity light at the end of the tunnel is no longer a decade or more away, it's a lot closer. But we also make sure the borrower understands that this reward is real, it's tangible, it's something that they can get their hands on at some point in time when they do the right thing, when they pay off their mortgage, when they refinance or when they sell their home.
It's good for borrowers, Pallotta says, because ultimately, they'll lose less than they would have. And it's good for banks, because they'd take a bigger loss on foreclosure.
Sound of kettle whistling
Paul Buck is brewing some coffee at his home in Las Vegas. He's owned the property for seven years, and is, like virtually everyone else in Las Vegas, underwater on his mortgage. Way underwater.
Paul Buck: By some calculations, the house may be worth $175,000 instead of what we owe on it, which is $295,000.
Buck is the perfect bait for the plan being offered by loan value group. He could really use the money he's spending on his mortgage to pay for his kids to go to college. And he's not all that attached to the house.
Buck: It will cost us $140,000 or $150,000 more over the next 10 years to keep paying our mortgage on the house than if we made a strategic default and just walked away.
He's not worried about taking a hit to his credit score, because he says he doesn't need much credit. And he says he's not swayed by the moral argument either. Just look at the investors that recently walked away from their $6 billion obligation at the Stuyvesant Town apartment complex in New York City, he says.
Buck: And they just said, "Well, it's only worth $1.8 billion, so now we're bailing out," and left the lender holding the bag. So you know, nobody cried about that and said, "Oh, you're bad people, what an immoral decision." They just said, "Well, that's business. Right? That's business." So that's kind of the attitude we have to take, too, I think.
Still, Buck says he's thinking twice. In Nevada, the lender can go after more than just his home if he walks away. Would he keep paying his mortgage if he could cut his losses with a wad of cash from the bank?
Buck: It might be possible. 'Course it depends on the cash lump sum.
That response makes perfect sense to behavioral economist Eric Johnson. He's the director of the Center for Decision Science at Columbia Business School. He says for borrowers like Paul Buck, it's more about psychology than math. And it's easier to convince people to stay in their homes than you'd think, because borrowers are generally more sensitive to short-term pain than they are to long-term gain.
Eric Johnson: So what happens if I'm thinking about walking away? What do I have to do first? Well, I have to pack up, move, take my kids, perhaps, to another school. Do lots of things that are unpleasant, probably some things that are embarrassing, like tell the neighbors I'm walking away.
And what are the benefits? When do they come? Well, I find this nice rental, and I save maybe $100, $200, even $500 a month. But that accrues over time, it happens over a long term, so basically if I'm sensitive to what happens now, walking away looks a lot less attractive.
Johnson says borrowers also have to consider the money they've already sunk into the house.
Johnson: One of the classic examples of this is: I'm in a restaurant, I'm hungry, I have to order the souffle early on in the dinner, because, of course, it takes an hour-and-a-half to prepare. So I have this delicious dinner, I'm stuffed, but here comes the souffle. Now, I've already paid for it, but if I don't eat it, I feel like I'm wasting that $15.
So he eats the souffle. That's something that banks and Frank Pallotta hope that a lot of underwater home owners decide to do too.
In New York, I'm Jeremy Hobson for Marketplace Money.
Vigeland: By the way, the Obama administration is planning a program that would give home owners cash not to stay in their homes, but to leave them through a short sale. That effort is supposed to get underway next month.
Comments
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From HI, 03/19/2010
"
the Obama administration is planning a program that would give home owners cash not to stay
"
Got it! First, taxpayers will donate bail out money to the bank which goes into Chapter 13 from spending too much on debt forgiveness. Secondarily, taxpayers will donate Nobama money to banks with non-performing loans, banks that hand out good-bye gift to walk-away consumer.
And another donation to Elizabeth Ann,
and another donation from the raggedy man,
raggedy raggedy raggedy man.
Ain't he an awful nice raggedy man
raggedy raggedy raggedy man
?
From Bellevue, WA, 03/15/2010
Curious to know if Loan Value Group uses real options analysis to help set the potential price (cash giveback) to homeowners. Seems that this is the perfect tool to ensure balance: don't give away too much, don't offer too little. Plus add in Mr. Johnson's heuristic biases, and you might have somthing that works.
From Elk Grove, CA, 03/15/2010
I think the Gov't should come up with a program that will allow the bank to sell the home back to the homeowner at either the market value or a percentage above the market value and still get the same write off they receive if they allowed a short sale or take the home in foreclosure. This will be a win win for everyone involved. This will help the economy to start stablizing at a much faster rate. Why make the homeowner leave their home only to sell it to someone at a lower cost than the homeowner is willing to make payment on?
From Simi Valley, CA, 03/13/2010
There is another reason people default on their loans. They reset... Say you have a five year arm and after 5 years the bank says its time to start that new payment that your loan guy and real estate guy said you would be able to refinance but couldn't. Well my idea which I have never heard will keep people in their homes. Cost taxpayers 0 make more money for the banks and reduce forclosures substantially. What could be so easy? Make the banks continue to take your current payment and extend the life of the loan out as far as it needs to be to pay off the principle. So easy... so why hasn't anyone suggested it yet?
From Colorado Springs, CO, 03/13/2010
The story seems to forget that many of these homes are actually owned by investors who bought into CDOs and various forms of
nefarious investments schemes cooked up by Wall Streets.
In such cases, the bank cannot make decisions for such investors. The mortgages are bundles sevral times over... so who know who owns what....
There lies much of the obstacle to unwinding the housing crisis, I think....
From San Jose, CA, 03/13/2010
This is just silly. Why would anyone believe that the cash lump sum is ever really going to materialize? It sounds like just another scam such as the ones lenders used to create the bubble in the first place. Just another way of trying to keep people in circumstances that are neither good for them nor the economy as a whole - but that protect the banks. Same with reducing interest - it's meaningless if the principal is still so far out of line with reality. Enough.
Without principal writedowns, there's no real financial reason to stay in homes that are severely underwater. Indeed, it may be just as ethical to walk as to stay; resources can be freed to spend in support of local businesses, and property prices will fall in line with their real values.
(For the record, I own a home, have significant equity, and make my mortgage payment comfortably. I have no personal interest in the situation.)
From Oxford, MI, 03/12/2010
Again, I am thinking that this new plan will not help many homeowners. It is just throwing a Milk Bone to the soon-to-be homeless people so that they can have a security deposit and first month's rent on their new abode. Big deal. I still say, why can't the lenders just re-write the mortgages at a reasonable rate of interest -- let's say 4.5%, reduce the amount of re-financing from about $4K to $1K, and then figure out a way to help them pay off their credit cards. Why does everyone think that the main problem is just the amount of the mortgage? The problem is that EVERYTHING keeps going up. As soon as it becomes June, gas is going to be $3 a gallon again. No one ever talks about how much you have to spend on groceries, how much more your utilities are this year than last year, even that the incentive plan of having more money in your paycheck now means that you don't have any money coming back from your taxes. What about all the home maintenance that people haven't had the money to keep up? When you haven't had money to get a new roof or replace a window or get that new hot water heater...it all adds up and even if the person wanted to stay in the home they still have to "look forward" to figuring out how to pay for all of that. So, when you look at the total picture, it is understandable that with the stress and the job outlook that people just give up.
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