Option ARM Suffering

[PerryChase]

Imagine a borrower purchased a $1 million house. At the reset time he owes $1.1 million. The house is then only worth $500k. What’s that borrower likely to do?

1) Keep on making payments on the $1.1 million loan to live in a $500k house?
2) Walk and let the bank have house?

I think the more expensive the houses, the more likely the borrowers are to walk.

[powayseller]

So the payment goes up 50% – 100%, the house is worth 10% – 50% less, so even if the guy *could* afford the higher payments, why would he bother? That’s the point, right Perry? If we extend that line of reasoning, what is the decision for anyone who is underwater to decide whether to pay or walk? What if the guy with the $1 mil house is too attached to his house to walk? Maybe he doesn’t want to pull his kids out of school, and he has a good job he doesn’t want to lose. What do you think?

[PerryChase]

Yes, PS, that’s the point. Even if the borrower could afford to keep on making payments on that $1.1 million note, he most likely wouldn’t if the house is then worth only $500k.

My prediction is that well-to-do people are smart. They’ll get emotionally “detached” very quickly when they realize that their homes are only worth 1/2. That that reason, I don’t think that upscale neighborhoods will be insulated from the downturn.

The borrower’s job should not be affected and he can simply relocate in the same neighborhood (for 1/2 the cost) so his kids stay at the same school.

[barnaby33]

The borrower’s job should not be affected and he can simply relocate in the same neighborhood (for 1/2 the cost) so his kids stay at the same school.

I don’t know anyone who has been through a foreclosure that is detached about it. My mother hid a recent bankruptcy from me for several years, she is smart. I realize that is only one example, but Perry you are being far too glib. Lots of people may detach to the extent that they realize they have to walk away, but its still very traumatic. Not just to them, but to friends and family even neighbors.

Josh

[no_such_reality]

PC, I don’t think the banks will let them walk that easily this time. A 1/2 million isn’t chump change, even to a mulit-billion dollar bank.

Also, what about deficiency judgements, it’s longer and more painful to foreclose, but if the bank is looking at that substantial of a loss, do you see a switch to judicial foreclosure so the lenders can exploit the lying in the ‘liar’s loans’?

Finally, we must keep in mind that most will never admit to themselves that their $800,000 house, that they owe $880,000 on, is really worth $400,000. most will never even realize, what they’ll know is they can’t sell it.

In all honesty, I’m suspecting the housing market is going to become really illiquid. Possibly to the point that the only thing available on the market is prior-foreclosure resales. Those resales will likely be in our target range of 40-50% from peak, but I suspect that’ll be all we have to choose from. People will rationalize that their house is really still worth $800,000, just once all these foreclosures clear out…

[sdrealtor]

“Possibly to the point that the only thing available on the market is prior-foreclosure resales. Those resales will likely be in our target range of 40-50% from peak, but I suspect that’ll be all we have to choose from.”

That would be very unfortunate because the best properties are unlikely to be among them.

[PerryChase]

I believe what’s different this time it that the slump will be deeper for the following reasons:

1) Thanks to the Internet, people have much better access to data so the knowledge that prices are down will be widespread. In 1990s I had to rely on my Realtor to give me data.

2) Our society has become much more mobile so people will need to move for different reasons. People are now using their homes as stepping stones to better homes, and they won’t want to be ride out the market in “undesirable” houses. The divorce rate might even spike putting even more houses on the market.

[powayseller]

sdrealtor, I disagree. The very best properties were on fire sale in the last downturn, and they will be again this time. (In my opinion, of course)

no_such_reality brings up a great point, and I agree with him. Let me give an example.

One of my favorite homes was purchased by a friend at 48% of the price of a comp that was sold just 18 months earlier. So she got 52% off just by waiting for the trough. I plan on finding hundreds of these types of deals in 2010.

To retain their anonymity, I will not give enough details that you can find them. However, they paid $ 96/sq ft, and the neighbor paid $200/sq ft just 18 months earlier. When I first met her, she told me they got a real good deal on their house, since it was purchased during the real estate slump.

[sdrealtor]

We’ll have to agree to disagree on this one. I agree with NSR but just think that the quality of the properties in his scenario will be less than optimal. Your example while valid is a sample size of one. I havent heard of any areas that dropped 52% in 18 months.

[powayseller]

sdrealtor, lots of properties dropped that much in the early 90’s. Even the best properties were in foreclosure, according to people who have lived through it.

[no_such_reality]

PS, I was here, don’t remember that. I remember everything being a wreck. I also don’t remember the homes dramatically depreciation in nominal dollars. They trickled down 10, 20K year, home medians were in the high twos/low threes. They took some hits, but not 50%. The bulk of the loss in the last down turn was due to inflation catching incomes up.

I also remember all my coworkers talking about wanting to get out of their upside down loan but not being able to. And others tough talking about getting the bank to forgive some of the equity loss, but it not occuring. We’re talking losses that pale compared to the equity run up lately.

I think the voice of San Diego site had the historical housing median price numbers on it. You can look, they simply didn’t implode, they trickled down.

50% in 18 months is an implosion.

[powayseller]

I was told prices dropped 25 – 35%. I think there were some very good deals to be had due to foreclosures, such as the one my friend got. I think this time, we will see more good deals like that. I was told there was a glut of foreclosures around Poway High School, an area considered one of the most desireable parts of Poway.

[PerryChase]

I also was here in 1990s slump. Prices did go down 25-35%. Carmel Valley (North City West at the time) was a mess and so was Faibanks Ranch. Habor Club and other developments downtown went bankrupt.

1990s is when San Diego lost its financial industry (Home Fed, Imperial Savings, Executive Life, etc…)

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