Monday, January 24, 2011

Consider Using A Mortgage Calculator, Amortization Table And Property Value Data For A Strategic Default

Part of our job at is to review other viewpoints about strategic default. This current post is inspired by another post we found while researching the universe of articles on strategic defaults and foreclosures.

We found this post entitled : “Should I Do a Strategic Default on my Mortgage?” by JLP in his blog All Financial Matters posted December 2, 2010.  

This question was posed by a reader of JLP's blog. The question and answer are as follows:
  • "I bought my condo at precisely the wrong time. I didn’t, however, listen to everyone telling me I could afford to buy more. I did a straight 30 year fixed that I could afford in reality. Of course I am incredibly underwater on my mortgage now. It is depressing, needless to say, and even more so when I feel as if my taxes are helping people who didn’t “do things the right way” and some companies who seemed to have contributed greatly to the problem and are not being held responsible...I live in Illinois, western burbs of Chicago...I bought for $139,000, now owe $122,000 and the most recent sale was $77,000...30 year, 6.75% (which was good then!) percent...When I bought I planned on staying 5 years or so and moving up (didn’t everyone?). I don’t *need* to move. I sure wish I could buy some of the houses on the market now though! For what I paid? I bring home (after taxes) about $40,000 a year. My mortgage + PMI + escrow is almost $1,100...I know there are people in much worse shape. If I lost my job this whine about underwater wouldn’t even exist, you know? Still – just the though of paying even MORE out when I feel like I am not getting any benefit is upsetting, depressing."
         The writer, JLP answers as follows:

         "First off, I don’t envy this guy’s position. That said, it could be much 
    • He could have to move right now. Fortunately, he does not have to.
    • His payment is around 33% percent of his take-home pay (even less if you factor in the mortgage interest deduction), which is reasonable (though on the high side of reasonable). He might have a hard time finding something else that will give him a payment in that range, especially when you consider the fact that he’s under water on his current mortgage.
    • Eventually, housing prices will stabilize and begin to move back up. The longer he stays here, the more likely he’ll see a rebound.
    • Even if the mortgage interest deduction is done away with, it will probably only be done to those who make more income.
    • Strategic default can lead to lots of headaches, which are laid out nicely in this article.
           Based on all the above (and not on any moral argument, which you 
           guys already know where I stand), I think I would stay where I was    
           and would not go the strategic default route. What are your thoughts?"

So JLP believes the homeowner should stay put and ride it out. We we have a few questions.

The first question is: With A Fixed Rate Mortgage, How Long Will It Take The Homeowner To Reduce The Principle Balance So He Breaks Even?

The homeowner said his property is worth $77,000 with a current mortgage balance of $122,000. We need to plug the numbers into a mortgage calculator and take a look at the amortization schedule. An amortization schedule is a table detailing each periodic payment on an amortizing loan (typically a mortgage), as generated by a mortgage calculatorAmortization is the process by which your loan principal decreases over the life of your loan. The amortization schedule will show what portion of your monthly payment is applied to interest and what portion is applied to principle. Almost every mortgage loan is structured to allow the lender to collect most of the interest up front. In other words, during the first 15 years of a 30 year mortgage loan most of your monthly payment will be applied to interest. You would think that your payments would be divided equally between principle and interests or perhaps most of your payment would be applied to principle however that is what we call "WISHFULL THINKING". Banks make money on interest so banks want that money upfront and first.  

So let's get to the mortgage calculator. You can visit this link for a mortgage calculator that produces an amortization table. The mortgage calculator also determines the monthly mortgage payments. Remember to use a mortgage calculator that provides an amortization schedule. You need three numbers for a mortgage calculator: 1.) The original loan amount or principle balance. 2.) The interest rate. 3.) The number of years on the mortgage. So let's use the numbers from the homeowner described in the JLP post. After putting in a principle mortgage balance of $122,000 with an interest rate of 6.75% over a 30 period we get the following results:
  1. The monthly principle and interest payments are about $800 per month.
  2. The homeowner will have to make monthly payments until 2028 to reduce the principle balance to $77,000. This is based upon the assumption that the homeowner's property value will remain at $77,000 for the next 18 years. Of course this is not likely. 
So, the next key questions is: Will The Homeowner's Property Value Increase Or Decrease Over The Short Term and Long Term?

That is a tough question. It's safe to assume that everyone's "gut" feeling is that property prices will be declining in the short term. How long will the decline last? When will we see property values rise? Will property values rise to enough to cover the drop over the past several years?

It is likely that property values will decrease in the short term. 

We can turn to the Case-Schiller Index considered the leading measure of U.S. Home prices. The November 30, 2010 press release indicates that there has been a broad decline in housing prices for the 3rd quarter 2010.  The press release further states: "Nationally, home prices are 1.5% below their year-earlier levels." This indicates that home prices have declined nationally over the year. Keep in mind certain neighborhoods are experiencing different price changes than others. So it is important to get property values based upon where you live.

In a recent article Forbes listed the top 10 cities where home values will rise in 2011 and the top 10 cities where home values will fall in 2011. The top 10 cities with rising values are: San Jose, CA; Santa Ana, CA; Bethesda, MD; Pittsburgh, PA; San Diego, CA; Oklahoma City, OK; Washington, D.C.; Austin, Texas; Chattanooga, TN & Boston, MA. The top 10 cities losing value are: Daytona Beach, FL; Lakeland, FL; Orlando, FL; Boise City, Idaho; Las Vegas, NV; Jacksonville, FL; Palm Bay-Melbourne-Titusville, FL; Tuscon, AZ; Cape Coral-Fort Myers, FL and Tampa-St. Petersburg, FL. 

Then there is Zillow provides property values, property information, and neighborhood information. Simply put a property address into Zillow's algorithm system for an instant value. In addition to Zillow, a local real estate agent can provide recent property sales information. 

In other words the homeowner must perform research to gauge the direction of property values in his neighborhood. 

So the final question is When will the homeowner get out of his financial trap?

The primary reason any property owner considers a strategic default is to protect their cash, savings, and wealth from a money draining asset. So any advice given to a property owner must take into account the primary reason for a strategic default. The homeowner stated this very desire. To quote the homeowner: "Still – just the though of paying even MORE out when I feel like I am not getting any benefit is upsetting, depressing."

So let's recap. JLP thinks the homeowner should keep the house because he doesn't have to move, his mortgage loan payment is 33% of his take home pay, housing prices will eventually move up, he has the mortgage interest deduction, and strategic default can lead to "lots of headaches". 

Is this sound advice? Especially since it will take 17 years before the principle balance of the mortgage equals the current property value. Is it worth the risk to make monthly payments for the next 1 years, 3 years, or even 7 years with the possibility of gaining no equity?  

The advice is principled. However, only time will tell if the homeowner doesn't waste all of his money and savings on an upside down property.  

1 comment:

  1. An Additional Security Fee is the fee taken to get an insurance policy that will cover your lender so that if you default on payments, he will not suffer any loss. You have to pay the Additional Security Fee and the premium along with your mortgage advance. Although you are paying the premium, remember that this policy is for the protection of your lender and not for markham