The latest housing crisis has been all about inflated home prices and underwater mortgages.
But not every borrower entering foreclosure is in an upside-down position. A new report from Fitch Ratings noted that a growing number of borrowers with positive equity are falling into foreclosure.
In fact, they claim such instances have “roughly doubled” over the past two years, meaning home equity is important, but it’s not everything.
Near Negative Equity Not Good Enough
You might be thinking that these people can just sell and cut their losses, but it’s not that simple when you consider all the costs involved with unloading real estate.
First off, you’ve got real estate commissions, which can be 6% of the sales price. Then there is the backlog of missed payments and penalties.
Fitch added that loans entering foreclosure today are 24 payments behind on average, which is more than double the pre-crisis, long-term average.
Assuming the sales price is enough to cover all the outstanding expenses, it still might not make sense for a homeowner with nowhere else to go.
After all, if they’re living “rent free” in a home they like/love, why go through the trouble of selling just to break even, only to end up without a house and burdened with moving expenses?
This is why you’ve got to take the negative equity numbers with a grain of salt. Yes, nearly two million homeowners have gotten their heads above water since 2012 thanks to rising home prices, but many still can’t sell, and certainly can’t buy another home if you consider the down payment required. Or the credit score needed.
You Shouldn’t Have Tapped Your Equity
While the current foreclosure situation is certainly a sad state of affairs, many of those facing foreclosure tapped their home equity along the way, often multiple times.
Per the report, 50% of loans entering foreclosure were cash-out refinances at origination, a number that has increased steadily since 2008.
So half of these borrowers pulled money out of their homes (and spent it somewhere), instead of paying down their original mortgage, and many probably did so at the height of the market.
These foreclosures may also involve second mortgages such as HELOCs taken out after the original mortgage. Again, you have to wonder where all the cash went.
For those still with some level of home equity, tapping it is basically impossible because of the restrictive LTV limits in place today. You can’t do a 100% cash out refi anymore…thank goodness.
Additionally, many of these loans were underwritten with subprime guidelines, meaning these borrowers don’t qualify for refinances, and can’t even keep up with reduced mortgage payments via a loan modification.
In fact, about half of all the loans that recently entered foreclosure had at least one unsuccessful loan modification.
Surprisingly, loans entering foreclosure recently were eight years old on average, compared to the pre-crisis average of 2-3 years.
It is somewhat amazing that these borrowers have held on so long just to lose their homes, especially at a time when home prices are at or near peak levels again in many parts of the country.
But lenders have been slow to process foreclosures, which may explain the deeper vintage.