Bailout

How mortgage default could get much worse

By Felix Salmon

Brent White, in his tour de force paper on how homeowners are guilt-tripped into remaining current on their mortgages even when doing so makes no financial sense, notes that non-profit organizations setting themselves up as friends of the consumer are in fact part of the problem:

A homeowner who turned to any number of credit counseling agencies would also find little sympathy – and much moralizing – should they announce their plan to walk on their ?affordable? mortgage. Gail Cunningham of the National Foundation for Credit Counseling declared for example in an interview on NPR: ?Walking away from one’s home should be the absolute last resort. However desperate a situation might become for a homeowner, that does not relieve us of our responsibilities.? Indeed, the uniform message of both governmental and non-profit counseling agencies (which are typically funded at least in significant part by the financial industry) is that ?walking away? is not a responsible choice and should be avoided at all costs.

Well, Gail Cunningham is back, with an inadvertently scary press release on the same subject (emphasis in original):

The National Foundation for Credit Counseling?s (NFCC) 2010 Financial Literacy Survey revealed data that supports consumers? ongoing efforts to stay in their homes. The survey found that the overwhelming majority of consumers, even those in financial distress, still consider their mortgage payment a priority. When asked if they were unable to meet all of their financial obligations, would they be more likely to keep their mortgage current, or their credit cards current, 91 percent of respondents said they would pay their mortgage first.

The survey also asked under what circumstances, if any, they would consider it justifiable to default on a mortgage. Only 23 percent of respondents answered that foreclosure is justifiable if the property is now worth less than what is owed on it. Further, 15 percent replied that there is no justifiable circumstance under which it would be acceptable to default on a mortgage.

?Taken together, the NFCC survey data brings us some encouraging news: consumers still place a priority on making their mortgage payment, less than one-fourth think that defaulting on a mortgage is justifiable simply because the property is underwater, and a significant number take mortgage obligations so seriously that they find no acceptable reason to default on a home loan,? said Gail Cunningham, spokesperson for the NFCC.

This news is not, in fact, encouraging. For one thing, it comes as little surprise to find out that people who are current on their mortgage payments say that their mortgage payments are a priority. But actions speak louder than words. Just ask FICO, for instance:

Reversing a long historic trend, mortgage default risk for consumers with high FICO scores now exceeds their credit card default risk, even though most credit cards are unsecured credit and mortgages are secured by real estate…

In 2009, 0.3 percent of consumers with FICO scores between 760-789 defaulted on real estate loans, compared to 0.1 percent who defaulted on bankcards.

?We?re identifying lending industry situations in FICO Score Trends that to our knowledge have never been seen before,? said Dr. Mark Greene, CEO of FICO…

Or Transunion:

The share of borrowers who are delinquent on their mortgages but current on their credit cards rose to 6.6% as of Q309 (from 4.3% in Q108), according to national credit bureau TransUnion.

At the same time, the share of borrowers that are delinquent on credit cards but current on their mortgages slipped to 3.6% from 4.1%.

But the NFCC’s survey data is not just useless: it’s worse than that, since it encourages complacency when in fact it should be cause for great alarm. It’s clear that the number of people defaulting on underwater mortgages is rising, and insofar as the NFCC survey tells us anything, it just tells us that there’s a lot of room for strategic default to become a much bigger problem than it is already.

Imagine, for instance, that a survey showed a large number of homeowners with 30-year fixed mortgages over 7%, and who had no intention of refinancing even with mortgage rates below 5.5%. On the one hand, that might be considered good news for banks: more money for them. But more realistically, it would be worrying news, since it would mean millions of people who could suddenly wake up one morning and realize how much more money they could have by changing their mortgage situation. When there’s an easy and obvious strategy which benefits consumers at the expense of banks, consumers are likely, sooner or later, to adopt it. The NFCC survey just shows that a lot of them just haven’t got to that point yet. But there’s a good chance that, eventually, they will.

Full post as published by Macroprudential on June 08, 2010 (boomark / email).