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Duh! Excessive mortgage debt causes high foreclosure rates

High foreclosure rates are caused by many factors, but by far the largest is a high loan-to-value ratio because it limits the borrowers options in default.

Option_ARM_PlagueDefaults are loan disease. There are many causes of the disease, from unemployment to loss of market value, but there is only one symptom that lenders care about — defaults. Patients in good health cure from disease more often than those in poor health. Borrowers with equity cure at better rates than those who are underwater or facing a rental savings enticement, and many who see better futures in different circumstances will walk away from the debts and succumb to the loan disease. In borrower’s terms, the cure for loan disease is delinquency; unfortunately, for excessive lenders borrower delinquency is death.

Curing Default

There are many factors that influence who will cure their loan and who will not, with the borrower’s equity position being among the most important.done_making_payments

When people have equity in their homes, they cure at very high rates because either the loan servicer will modify the loan or force a sale. Delinquent owners generally choose to sell and obtain their equity rather than lose it to foreclosure; therefore, borrowers in default with a low Loan-to-Value (LTV) will cure either by loan modification or open market sale at nearly 100% rates.

As LTVs get higher, percent equity or equity position gets lower; as the equity position gets smaller a number of negative factors work together to lower cure rates quickly:

  • Lenders feel less security extending credit.
  • Loan modifications are more difficult to obtain.
  • Success of loan modifications declines.
  • It becomes more difficult to sell, particularly when equity falls to zero.
  • Absent faith in appreciation, borrowers have little incentive to cure.
  • If savings by renting is significant, borrowers have incentive not to cure.


The combination of these factors means that cure rates fall off to nearly zero as homeowners go underwater. If borrowers fail to cure their loans, lenders chose between allowing the delinquent borrower to squat (living payment free), or the lender must foreclose; therefore, the same factors that cause cure rates to drop cause foreclosure rates to increase.

While it may be common sense that excessive debt causes distressed sales and foreclosure, apparently policymakers are either ignorant to this fact or intentionally ignoring it because recently policymakers have pushed for lax lending standards and low down payment loans. CoreLogic conducted a study to ensure neither policymaker excuse is valid.

Ability-to-Leverage Drives Foreclosure Risk

Despite A Static Homeownership Rate Last Five Decades, Default Risk Exponentially Higher

Sam Khater, February 02, 2015

Leverage is known to play an important role in loan default, but while theoretical research on leverage exists; to our knowledge there has been virtually no long-term data driven empirical analysis on the impact of leverage on residential foreclosure. … This is an especially timely topic given that policy makers have recently attempted to thaw the tight lending environment by reducing the price and expanding the quantity of low down payment real estate credit.

The minimum down payment should be at least 10% to provide a buffer for lenders to greatly reduce risk of loss. If a borrower lost his or her job the day after closing escrow and couldn’t afford to make payments, they would have to put the property on the market and sell.

Since the buyer was the most aggressive bidder on the property, they will need to discount the property to find a new buyer, perhaps 2%. Further, as a seller they will have to pay various closing costs and fees which will cost another 2%. And last but not least, they will have to pay an agent to sell their house, so that’s another 6% gone. If you add those costs up, the total loss will be about 10% of the initial purchase price.

At any down payment level under 10%, owners can’t sell the property if the become financially distressed; if they can’t complete an equity sale, they likely become a foreclosure.

CoreLogic research highlights four key findings.

First, while homeownership rates today are the same level as five decades ago, foreclosure risk is two to three times higher.


Second, the primary driver of default risk over this period has been leverage. Leverage has played such a strong role that has rendered changes in income and savings as insignificant drivers of default from a long-term macro perspective.

Since the beginning of the foreclosure debacle, many have tried to spin the crisis as one of unemployment. I’ve consistently maintained the problem was one of debt, and it’s most debilitating manifestation, Ponzi borrowing. A great many people became dependent upon fresh infusions of debt to supplement their income, a Ponzi scheme. When these borrowers were all cut off at the same time during the 2007 credit crunch, millions of personal Ponzi schemes simultaneously collapsed, and the loss of this demand debilitated our economy and lead to millions of foreclosures.

Third, the stabilization in foreclosure rates in the 1970s and 1980s was driven by high inflation rates, which propelled nominal home prices and reduced aggregate LTV, thus lowering default risk – a reminder of real estate’s role as a hedge against inflation.

yellen_raise_ratesThis is another reason the federal reserve will not raise interest rates in 2015. Inflation is good for borrowers and lowers default risk for lenders when the system is plagued by excessive debt.

Fourth, the centerpiece of government regulations to help make the mortgage market safer for consumers was an income based ability-to-pay rule manages delinquency risk, but is less aimed at the market’s foreclosure risk.

Quite honestly, I have no idea what they are talking about here. The ability-to-repay rules manage delinquency risk by ensuring borrowers have the ability to repay, something lenders didn’t care about during the housing bubble. If borrowers don’t become delinquent, they don’t end up in foreclosure, so it seems to me that managing delinquency risk does manage foreclosure risk.

The Role of Leverage in Default Risk

Given that homeownership rates today are at similar levels as the early 1960s, what has driven the higher foreclosure rates? … The LTV ratio and unemployment rate stood out as the most important variables, with the LTV ratio by far being the most important variable.

This should not be surprising because the higher the LTV, the more the borrower’s options are limited. If they can’t cure, and if they can’t sell, foreclosure becomes a likely outcome.avoiding foreclosure

To illustrate the impact of the home price recovery on foreclosure rates, the model was used to break down how much of the recent decline was due to price increases versus all other variables combined. Between 2011 and 2014, foreclosure rates fell by 1.5 percentage points and the rise in prices has accounted for 1.4 percentage points of the decline. In other words, 91 percent of the drop in the foreclosure rate is due to the drop in leverage via higher home prices. Unemployment and the remaining variables accounted for the small remaining portion of the decline.

This is a classic error of correlation not being causation.

Yes, foreclosures declined significantly from 2011 to 2014, but rising home prices was not the reason — the real reasons foreclosures declined is because lenders changed policies. Prior to 2011, lenders processed foreclosures at a rate greater than the market could absorb, so house prices fell. In 2011, lenders changed their policies and began aggressively modifying loans or allowing borrowers to squat to stop foreclosure and to stop flooding the MLS with supply.

The change in lender policy toward foreclosure was the real cause of the decline in foreclosures, not rising home prices. In fact, the CoreLogic analysis puts the cart in front of the horse: house prices went up because foreclosure went down, not the other way around. The data clearly shows the decline in foreclosures and MLS inventory preceded the bottom of house prices in March 2012, and a cause must precede the effect.no_foreclosure_creepy

Conclusion and Policy Implication

CoreLogic findings illustrate how important leverage has been both historically and in today’s recovery. While leverage is the dominant driver of foreclosure trends, the unemployment rate captures the impact of short-term economic cyclical fluctuations.

This conclusion — backed by hard data — should put to rest the bogus claims that the waves of foreclosures was caused by unemployment.

A less important but still influential factor has been periods of accelerating inflation, which ease the burden of the monthly mortgage payment and masked the rise in leverage via higher nominal home prices. Interestingly, the savings rate and household income were not at all important, which was a surprise given that traditional underwriting focuses on affordability.

It is somewhat surprising that a high savings rate wouldn’t have buffered more borrowers, but it is not surprising at all that income was not a factor because bad loans of all sorts were given to every income bracket. Perhaps this study will definitively establish that it was not a subprime housing bubble, but rather a broad-based financial mania embraced by all income brackets.

Over the next year the continuing improvement in prices should help further reduce leverage, but the renewed emphasis on low down payment lending may in the future beyond 2015 lead to an increase in leverage.

Bankers want to start the party all over again. They need to qualify more borrowers at higher prices to bail out their bad loans from the last bubble, so they lobby for relaxed standards on government-backed loans to take out their bad bubble-era loans. If the new loans go bad in another bout of delinquencies, lenders really don’t care because they won’t feel the pain of the losses — the taxpayer will.


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Irvine Renter
26-02-2015, 06:59

New home sales stall out in January, falling 0.2%

Sales of new single-family houses in January 2015 were at a seasonally adjusted annual rate of 481,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development.

This is 0.2% below the revised December rate of 482,000, but is 5.3% above the January 2014 estimate of 457,000, considered a weak level.

The Wednesday report piles onto a series of bad news for the housing industry.

The year is off to a bad start for housing in terms of housing starts, completions and permits. Existing home sales tumbled in January, and mortgage applications have been spiraling downward in February, giving away most of the gains made in January.


Irvine Renter
26-02-2015, 07:01

Case-Shiller: “The housing recovery is faltering”

The National index was slightly negative in December, while both composite Indices were positive. Both the 10- and 20-City Composites reported slight increases of 0.1%, while the National Index posted a -0.1% change for the month. Miami and Denver led all cities in December with increases of 0.7% and 0.5% respectively. Chicago and Cleveland offset those gains by reporting decreases of -0.9% and -0.5% respectively.

“The housing recovery is faltering. While prices and sales of existing homes are close to normal, construction and new home sales remain weak. Before the current business cycle, any time housing starts were at their current level of about one million at annual rates, the economy was in a recession” says David Blitzer, managing director and chairman of the Index Committee at SP Dow Jones Indices. “The softness in housing is despite favorable conditions elsewhere in the economy: strong job growth, a declining unemployment rate, continued low interest rates and positive consumer confidence.

Home prices saw a slight increase in nine cities covered by the SP/Case-Shiller Home Price Indices in December.

Both the 10-City and 20-City Composites saw year-over-year increases in December compared to November.

The 10-City Composite gained 4.3% year-over-year, up from 4.2% in November. The 20-City Composite gained 4.5% year-over-year, compared to a 4.3% increase in November.

The SP/Case-Shiller U.S. National Home Price Index, which covers all nine U.S. census divisions, recorded a 4.6% annual gain in December 2014 versus 4.7% in November.


Irvine Renter
26-02-2015, 07:03

Latest data shows housing economy sluggish

Lindsey Piegza, chief economist at Sterne Agee, says she thinks this shows a housing market that’s flat.

“Coupled with a near 5% decline in existing sales, this morning’s decline in new sales suggests the housing recovery remains muted. Yesterday’s monetary policy testimony revealed a dovish Federal Reserve Chairman,” Piegza said. “Of course, given the slew of disappointing economic news including back-to-back months of negative retail sales, a one-year low on the ISM, and four months of negative durable orders in the last five, not to mention increasing concerns regarding a further decline in inflation and a still-sluggish housing market, and it’s hard to imagine why the Fed wouldn’t sound dovish in their assessment of the economy, as well as hesitant in their ability and willingness to initiate liftoff.

“This morning’s home sales report further confirms the Fed’s assessment of a ‘slow’ recovery in the US housing market and offers yet another reason for an extended timeline for liftoff,” she said.

Rick Sharga, executive vice president at, told HousingWire he sees housing entering a “boring plateau.”

“That’s not a bad thing considering how bad the recession was — there’s a reason it was called the Great Recession,” Sharga said. “We’re entering a period of boring but slow, steady growth.”


el O
26-02-2015, 07:08

There’s a new mortgage crisis brewing

In 2008, the nation entered into a financial crisis widely believed to have been caused by excesses in the residential mortgage industry. By 2010, the nation thought it had put in place a series of measures that not only would resolve the crisis but would insure that it never happened again.

Yet, here we are in 2015 looking at another potential mortgage crisis. Only this time it is different. In 2008, funds flowed in waves into the mortgage industry. In 2015, it appears the funds are drying up.

Savvy commentators, seeing a weakening in housing activity, began opining: “It’s the interest rates” … “It’s the housing prices”

“Millennials and Generation X and Y’ers would rather rent apartments at higher prices than buy houses.”

*Paging the ‘attack the messenger’ deflector squadron… you’re clear for take-off, LOL.


Irvine Renter
26-02-2015, 08:00

I am using his comments in an upcoming post.

It seems to me that if the money to fund mortgages is drying up, then the returns on mortgages must be too low. No amount of regulation will prevent Wall Street from funding a good investment, so if money is lacking in mortgages, then yields must rise — which means mortgage rates must go up.


el O
26-02-2015, 08:14

Yep, and it is homedebtors who carry the roll-over risk, NOT banks. This is the reality that sell-side toadies don’t want to talk about.


Mellow Ruse
26-02-2015, 09:27

In 2008, funds flowed in waves into the mortgage industry.

Can anybody explain this? I was in the mortgage industry in 2008 and I remember the exact opposite happening. In fact, I remember the media referring to a credit crunch so apparently others noticed the same thing.


Irvine Renter
26-02-2015, 08:03

Morgan Stanley pays $2.6 billion in mortgage-bond settlement

Revel in the schadenfreude of bank pain

Morgan Stanley (MS) said it reached an agreement in principle with the United States Department of Justice and the United States Attorney’s Office for the Northern District of California to pay $2.6 billion to resolve certain claims the financial enforcers intended to bring against the investment bank.

A deal was expected to be coming very soon.

“In connection with the resolution of this matter, the Company has, subsequent to the announcement of the Company’s 2014 earnings on January 20, 2015, increased legal reserves for this settlement and other legacy residential mortgage-backed securities matters by approximately $2.8 billion, which increased Other expenses within the Institutional Securities business segment for year ended December 31, 2014,” the filing with the Securities and Exchange Commission said.

“This decreased income from continuing operations by $2.7 billion and diluted EPS from continuing operations by $1.35 for the year ended December 31, 2014″

In July, Morgan Stanley agreed to pay $275 million, after months of fine-tuning the deal, to settle charges brought by the Securities and Exchange Commission over defrauding investors in a pair of residential mortgage-backed securities.


26-02-2015, 09:37

How much ya wanna be that before MS pays the $2.6 billion, the amount gets appealed and negotiated downward?


26-02-2015, 09:51

You can’t appeal an agreement you make, only an unfavorable judgment.


26-02-2015, 09:53

How much of that $2.6 billion will be tax-deductible?


Irvine Renter
26-02-2015, 08:04

Survey: Delinquency, Foreclosure Inventory Rates Fall to Lowest Levels Since 2007

Higher home prices allow more borrowers to cure with equity sale

Both the delinquency rate and the foreclosure inventory rate in Q4 2014 for residential mortgage loans fell to their lowest levels since 2007, according to the Mortgage Bankers Association’s National Delinquency Survey released Wednesday.

The delinquency rate, which includes loans that are at least one payment past due but not loans in foreclosure, fell to a seasonally-adjusted rate of 5.68 percent in Q4 for all mortgage loans outstanding at the end of the quarter, the lowest level since the third quarter of 2007. The delinquency percentage in Q4 represented a decline of 17 basis points from the previous quarter and 71 basis points from the same quarter a year earlier.

The percentage of loans in foreclosure for Q4 also experienced a sharp decline, down to 2.27 percent – the lowest foreclosure inventory rate since the fourth quarter of 2007. The foreclosure inventory rate for Q4 was down 12 basis points from the previous quarter and 59 basis points year-over-year.

The percentage of loans on which the foreclosure process began ticked slightly upward by two basis points quarter-over-quarter in Q4, up to 0.46 percent. This was still a decline of eight basis points year-over-year, however. The serious delinquency rate – percentage of loans either 90 days or more past due or in foreclosure – fell to 4.52 percent, a drop of 12 basis points quarter-over-quarter and 89 basis points year-over-year.

“Delinquency rates and the percentage of loans in foreclosure decreased for another quarter and were at their lowest levels since 2007,” said Marina Walsh, MBA’s Vice President of Industry Analysis. “We are now back to pre-crisis levels for most measures. The foreclosure inventory rate has decreased every quarter since the second quarter of 2012, and is now at the lowest level since the fourth quarter of 2007. Foreclosure starts ticked up two basis points, after being flat last quarter, largely due to state-level fluctuations in the speed of the foreclosure process. Compared to the same quarter last year, foreclosure starts are down eight basis points.”


el O
26-02-2015, 11:04


oh.. and cha-ching


Jessica Sala
26-02-2015, 14:41

Great post. In our area in South Florida, we have many “boomerang” buyers whose were hit when the market crashed, but are now at a place to buy again, BUT we are seeing many have a tought time because of high LTV’s.


Irvine Renter
26-02-2015, 15:05

We haven’t seen many boomerang buyers here. Of course, since the crash was so deep and hurt so many in Florida, I imagine most are boomerang buyers because so many lost their homes in foreclosure.

With the difficulty of the recession and the uncertainty of whether or not an old lender would seek collection, I image most of the buyer pool has little or no savings. The 3% down program with the GSEs may help a little, but people are going to have to have a little discipline to save a down payment in order to buy again.

Thanks for your comment.


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