Strategic Defaults On The Rise

Tim Iacono discusses a startling trend of homeowners abandoning their expensive underwater mortgages and moving down the street to rent a similar home for a fraction of the price. With some homeowners upside down by $100K or more, many will see a "strategic default" as a compelling option. See the following post from The Mess That Greenspan Made.

Today's must-read housing story comes in this front page Wall Street Journal report about families in Palmdale, California walking away from their big underwater homes (and monstrous mortgages) to go rent the house down the street for half the monthly payment.

Schoolteacher Shana Richey misses the playroom she decorated with Glamour Girl decals for her daughters. Fireman Jay Fernandez misses the custom putting green he installed in his backyard.

But ever since they quit paying their mortgages and walked away from their homes, they've discovered that giving up on the American dream has its benefits.

Both now live on the 3100 block of Club Rancho Drive in Palmdale, where a terrible housing market lets them rent luxurious homes -- one with a pool for the kids, the other with a golf-course view -- for a fraction of their former monthly payments.

"It's just a better life. It really is," says Ms. Richey. Before defaulting on her mortgage, she owed about $230,000 more than the home was worth.

People's increasing willingness to abandon their own piece of America illustrates a paradoxical change wrought by the housing bust: Even as it tarnishes the near-sacred image of home ownership, it might be clearing the way for an economic recovery.

Well, that's one way to get the housing market back to more normal price levels - take the decision out of the hands of the U.S. government via their various mortgage modification programs and give the property directly back to the banks.

It looks like "strategic defaults" could be the next big development in the U.S. housing market, at least according to this report in HousingWire the other day on a recent study of the subject - they're on the rise, now accounting for about a quarter of all mortgage defaults.

Those of you who recall my housing story, as told here a year or two ago, might remember that we too lived in Palmdale, California at one point, 20 years ago.

It's pretty amazing too see how home prices have changed there over the years.

For what seemed like forever, you could get a decent sized house out there - some 40 miles away from the San Fernando Valley, just north of Los Angeles - for $99K or less.

Then, when the late-1980s California housing boom really got going, even a modest place would go for $150K to $170K - that's when we bought our first home.

Once this first housing bust ran its course in the mid-1990s, homes that went for $150K to $170K at the peak fetched under $100K again.

Fast forward to around 2006 and this same home may have sold for $250K or $300K.

Now, according to Zillow, they're back to about $120K.

It all sounds too familiar - fortunately we learned our lesson the first time around and sometimes I wonder if anyone else did. I've lost touch with most of the people I knew back then, but I did hear of one guy who bought a place for about $375K back in about 2004.

He's probably upside down by $100K or more.

Anyway, this story is well worth a look. They have a pretty neat interactive graphic for the Palmdale properties that are the subject of the report, another graphic showing how this trend is playing out nationally, and over 300 comments.

Some highlights:

Thanks to a rare confluence of factors -- mortgages that far exceed home values and bargain-basement rents -- a growing number of families are concluding that the new American dream home is a rental.

Some are leaving behind their homes and mortgages right away, while others are simply halting payments until the bank kicks them out. That's freeing up cash to use in other ways.

Ms. Richey's family of five used some of the money to buy season tickets to Disneyland, and plans to take a Carnival cruise to Mexico in March. Mr. Fernandez takes his girlfriend out to dinner more frequently. "We're saving lots of money," Ms. Richey says.

Well, it's nice to see that this trend is boosting the Southern California economy, a view that will probably soon go mainstream as more and more people say, "Look, I'm helping the economy by stiffing the bank".

Analysts at Deutsche Bank Securities expect 21 million U.S. households to end up owing more on their mortgages than their homes are worth by the end of 2010. If one in five of those households defaults, the losses to banks and investors could exceed $400 billion. As a proportion of the economy, that's roughly equivalent to the losses suffered in the savings-and-loan debacle of the late 1980s and early 1990s.

The flip side of those losses, though, is massive debt relief that can help offset the pain of rising unemployment and put cash in consumers' pockets.

For the 4.8 million U.S. households that data provider LPS Applied Analytics estimates haven't paid their mortgages in at least three months, the added cash flow could amount to about $5 billion a month -- an injection that in the long term could be worth more than the tax breaks in the Obama administration's economic-stimulus package.

"It's a stealth stimulus," says Christopher Thornberg of Beacon Economics, a consulting firm specializing in real estate and the California economy. "The quicker these people shed their debts, the faster the economy is going to heal and move forward again."

There are lots of pretty interesting human interest stories along with some detailed financial data on loan modifications that were offered and declined.

You'd have to think that, in places like California where so many homeowners owe so much more than their houses are now worth, this trend might snowball.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.