Go out to the parking lot
And you get in your car
And you drive real far
And you drive all night
And then you see a light
And out comes a man from Mars
And you try to run
But he's got a gun
And he shoots you dead
And he eats your head
An interesting white paper was released last month by Fed economists looking into a decision faced by many homeowners today: when to default. Specifically, the paper entitled "The Depth of Negative Equity and Mortgage Default Decisions" looks to divine whether borrowers exercise their implicit "put" option when it is in their interest.
Looking at borrowers from Arizona, California, Florida and Nevada (Can we make a PIIG-like acronym there?) who purchased their homes in 2006 using non-prime mortgages with 100 percent financing, these researchers found that almost 80 percent of borrowers defaulted in three years with a median equity level of -62 percent. This brings up the question: At what level of home equity does it start to make sense to "walk away" from your house? Fewer and fewer proclaim that "never" is the right answer believing that if you signed up for a loan, you should pay it back no matter what. Others view the bankruptcy route as a financial option — one that becomes more attractive the more upside-down you get on your house.
Your own particular view probably says a lot about how you make decisions and how strongly you stick to your commitments.
But before you come to your own conclusion, consider that the typical homeowner described above is basically paying above-market rents for his or her house realizing he or she may never participate in any upside. This should be acceptable for a short period of time as the transactional cost of relocating can be significant (especially given the downtrade in quality), but eventually it can seem horribly counterintuitive.
In addition, walking away entails a hefty duty in the form of damage to your credit rating which you may need to rely on in the future. (Bankruptcy may follow but only if/when the lender comes after you … and they are quite busy these days).
But given this study only looks at those who put zero down, we might safely conclude these people are financial risktakers to begin with.
Putting all of this together, perhaps it's a wonder borrowers would wait until they are at -62 percent before walking away. What were they thinking at -40 percent or -50 percent?
Now, I'm not advocating such borrowers should shirk their duties to the lenders, but I do believe in making appropriate financial decisions at every point possible. It's hard to say what I would advocate if I were put into such a position, but I don't think I would entirely rule out walking away.
In the poker world, they call this an "alien problem," meaning the only way I can even think about being in this situation is to imagine aliens abducted me for a time and then brought me back to earth to find myself in this situation. I simply can't imagine getting there in the first place.
Then again, given their sample size consists of a mind-boggling 142,918 individuals, there may be alien life out there. If so, it is probably more intelligent.
Both existing home sales and new home sales disappointed in May, falling 2.2 percent and 32.7 percent respectively. New homes sold dropped to a record low of a 300,000 annual rate as the $8,000 homebuyer tax credit expired. Looking ahead, total months' supply of homes for sale have dropped to 8.3 from 9.4 a year ago.
For the fourth time in a row, Kansas City Fed President Thomas Hoenig dissented at the Fed's FOMC meeting, as he believes that "continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted." The mere fact his dissent has been worded so strongly in the statement suggests his arguments are being heard.
The Bureau of Economic Analysis' third estimate of first quarter GDP came in at 2.7 percent, down from a previously estimated 3 percent. There was a heavy downward adjustment of the consumption component resulting from higher price indices primarily in healthcare and financial services.
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