The Fed found that "The possibility of price appreciation and the costs of default move the rational default point well below the underwater mark." Even someone sitting on an adjustable-rate mortgage that is underwater and due to reset will likely stay in their home because the "cost of maintaining the option by not defaulting is low."
The Fed believes the rational borrower will wait as long as possible before the reset to make the decision about whether or not to default. They will wait to see what happens to house prices. "On average, borrowers wait for prices to decline further before deciding to default."
That's because it's a "heads-I-win, tails you lose" situation "vis-a-vis the lender." If the house price falls further, the borrower can still decide to default, which means a further loss to the lender but no additional cost to the borrower. if the house price recovers the borrower gets the full advantage of that recovery. So the Fed concludes, "With both upside potential and downside protection against future losses, the borrower rationally should wait before defaulting."
Browse through photos of millions of home listings or search foreclosure listings Jon Maddux, CEO of You Walk Away, thinks the current lull in defaults may just be people waiting to see what happens after the current moratoriums on foreclosures. With the "recent media focus on the moratoriums" and the mortgage investigations "many borrowers are poised and waiting to make their next move." He believes "borrowers will continue to strategically default while their home values are significantly underwater." Which is still true in states such as California, Arizona, Nevada and Florida.
When will strategic default no longer be an issue? Maddux believes that will happen "when the housing market improves. For this to happen, the banks need to unload the shadow inventory." The moratorium "will push recovery off" but "will give many strategically defaulting as well as struggling homeowners additional time to put their financial affairs in order."
Maddux does think the public view toward homeownership has changed. "Many people are rewriting the American Dream. With the housing market in disarray, buying the home with the white picket fence is not a viable option for many, nor at this time would it be a wise one." Until one thinks the market has bottomed out, a purchase now could mean it would take three to five years to recover. Maddux concludes, "Many are realizing that they can rent that home with the white picket fence, without the responsibility and expense of owning."
So what will it take to stabilize the market and see the end to defaults? Obviously the critical issue is jobs. When people are stuck in a house that is underwater and they can't find a job where they are, their only choice often is to default and move to where they can find jobs. Job growth is the key to any market recovery, yet people are waiting to see where house prices go before making any decision on default.
Lita Epstein has written more than 25 books including "The 250 Questions Everyone Should Ask About Buying Foreclosures."
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