Voluntary or “strategic” mortgage defaults are challenging governmental efforts to resolve the real estate crisis.  But what are strategic defaults?

“Strategic defaulters often go straight from perfect payment histories to no mortgage payments at all. This is in stark contrast with most financially distressed borrowers, who try to keep paying on their mortgage even after they’ve fallen behind on other accounts.”

In other words, one out of every five homeowners who defaults today is voluntarily walking away from their mortgage, even though they can afford to make the payments.  That’s almost 300,000 people in 2007, and twice that number in 2008. Strategic defaults are higher in markets where home values have cratered since 2006. In California last year, the number of strategic defaults was 68 times higher than it was in 2005.

What are the consequences?  Well, the penalties can be stiff.  A consumer with a mortgage default on their credit history will  a) pay higher rates on all loans and credit cards,  b) be unable get a mortgage for at least two years, and  c) have  employment challenges with employers who demand clean credit. Yet 18% of those in default are willing to pay this price…

“Strategic defaulters may know that their credit scores will be severely depressed by their mortgage abandonment, Tantia said, but they appear to look at it as a business decision: “Well, I’m $200,000 in the hole on my house, and yes, I’ll damage my credit,” he said of defaulters. But they see it as the most practical solution under the circumstances.”

Who does this?  You might be surprised at the answer.  Statistically, people with higher credit scores, larger mortgages and/or multiple properties are more likely to walk away.  They seem to have adopted the attitude that ” it’s just business.”

As if to underscore what many people are beginning to believe, some economists believe the U.S. Housing market is now undervalued by 3.8% and given the continued downward spiral may “overshoot fundamental valuations on the downside.”  The bad economy and scared consumers are now holding back the recovery according to one Global Insight senior economist, and prices are continuing to fall.

If that’s true, then it’s time to think about buying.  Two other interesting pieces of anecdotal evidence fit that puzzle.

My appraiser recently told me that he has stopped completing the replacement cost section of the appraisal because today’s prices are so far below replacement costs that the figure is meaningless in the context of normal loan.

A home builder friend exclaimed recently that he could not build and sell a home for a profit today if the land was free.  I can see that…I’ve recently done a few loans on newer homes in South Placer County at prices under $100 per s.f.!

Despite the weak housing market, or maybe in a strange way because of it, Sacramento has made Kiplinger’s 2008 Top Ten Best Cities to Live, Work, & Play.

If you ask Sacramentans where they are from, you’ll get a surprising array of responses. As a Bay Area transplant myself, it never surprises me to encounter other S.F. Bay Area people who have moved for quality-of-life reasons to this once quiet enclave of rivers, hills, bike trails, and growing number of restaurants, wine bars, theaters, and clubs. After all, we were all driving past the place for years on our way to Tahoe before we ever decided to get off the freeway and explore its tree lined streets. The place doesn’t yield its secrets to those who rush by intent on other destinations.

The ones that catch me off guard are the Sacramentans whose journey began in distant places like Eastern Europe, Southeast Asia, and Scandinavia. How in the heck…? But as they say, it’s a small world, and growing smaller.

In any case, word is out. And it’s no longer accepted as fact that Sacramento’s only attribute is it proximity to interesting places. It has become a destination with lots to do and enjoy. And with the recent deflation of the real estate bubble, it’s more affordable and attractive than ever. Go Sacramento!

Even as the Sacramento real estate market’s lower price range turns frothy once again with first-time buyers and investors slugging it out over for bank foreclosures, the lending noose draws a little tighter.

The Pitfalls of Buying Auction Properties

A client called last week. She had purchased a home–a condo actually–at auction last November, and she got a great price. However, she was unable to arrange a loan because the condo was “non-warrantable”, a term that means the condo project didn’t meet Fannie/Freddie requirements. After paying late fees and penalties for failure to close on time, and not wanting to lose their deposit, she pulled money from their home on an equity line and paid cash for the condo.

Now she wants to refinance the condo and pull some of her cash back out. The trouble is, lenders have reinstituted “property seasoning” requirements and tightened up the cash-out rules. Fannie Mae and Freddie Mac now require 12 months “seasoning” before she can refinance and get any cash back out of that condo.

Moral of the Story

I hear frequent tales of all-cash buyers in the market. It makes sense. Some of these bank-owned properties are so trashed that banks won’t lend money on them. The only solution is to buy for cash, fix the place up, and then get the loan when the property is in decent shape.

Now, that game is over. I think lenders want to finance responsible investmentments, and they’re sick of “flippers” and people trying to make a quick buck. So, watch your step. And if buying for cash was going to be your strategy, plan to have your money tied up for a bit longer.

After 3 1/2 years of a real estate market in full retreat, affordable prices have once again sparked a frenzy of buying activity. Buyers are back. Some are first-time home owners previously sidelined by an overpriced market or frightened off by the free-fall in values. Some are investors who can now achieve a break-even cash flow while buying at the nadir.

Banks, heavily laden with foreclosures, are taking advantage of this turn of events by stoking the bidding fire with aggressively priced REO properties. Its the eBay syndrome. Draw people in with low prices and let their emotions carry the price up. It works.

I am amazed too at the money that has emerged to take advantage of this. Reports of all-cash buyers (investors mainly) are frequent, and I have refinanced homes for clients, withdrawing enough cash to purchase investment property without financing restrictions. That is almost a necessity in cases where the property condition would preclude new financing.

So with prices bouncing off a hard floor and the sudden release of pent-up demand, the bottleneck seems to be with financing. Lenders are still reining in LTVs, raising credit score requirements, demanding repairs on rough properties, and generally behaving the way you or I would if we were worried about being able to sell these loans to investors.

Still, for those who can document income and good credit, there are still options. And a little down payment can do wonders. In fact, its a lot like it was a decade ago. And that makes pretty good sense.

Real estate buying activity in Sacramento is highly concentrated in the foreclosure sector. Makes sense. Buyers want the best deal they can get, and bank-owned properties appear to offer the best chance for that. But financing those REOs isn�t always easy, especially as shrinking bank liquidity pulls the lending noose tighter.

The Problem with �As Is� Sales

Many bank owned properties have been abused or poorly maintained. The banks who now own them would prefer to sell �as is� to avoid throwing good money after bad. But you can bet those same banks wouldn�t finance those homes now if asked. Prices are even lower if the bank hasn�t had to spend money on fix-up, but securing a loan on a roughed-up property is a growing challenge

Traditionally, lenders are concerned with two categories of repairs: habitability and health & safety issues. Conditions that impair habitability include kitchens lacking appliances or cabinets, non-functional sink or toilet fixtures, damaged or removed flooring, or a leaky roof. Health & safety issues are self explanatory but can include even minor items like missing electrical outlet covers. Banks have always required that these items be repaired prior to close. But it�s getting tougher as banks balance sheets dry up, leaving them extremely vulnerable if they originate a loan that cannot be sold off immediately in the secondary market.

A Few Possible Solutions

Here are a few ways to deal with this challenge.

What emerged as a brief flurry of activity appears to have developed into buying trend. Sacramento prices�at least in some areas�may have finally found a bottom.

How do we know this? Although the activity seems highly concentrated in the bank-owned property arena, it has become common for buyers to have competition. Investors and first time buyers are competing for properties at the bottom, often driving up prices beyond that asked by the bank/owner. According to agents I know, there are many all-cash offers among the buyers out there.