Bay Area Mortgage Limbo

Tens of thousands on Bay Area homeowners are behind on their mortgage payments, but have not yet received a Notice of Default that would officially start the foreclosure process.

Some are attempting short sales. Some have walked away. Some are living for free until they are kicked out. Some are trying to get a loan modification and were told that they had to be delinquent on their mortgage to qualify. Many will eventually end up being foreclosed, but we don’t really know what percentage it will be and we don’t know how long the banks will drag out the process.

These homeowners, or “homeowers”, contribute to the Bay Area’s shadow inventory of homes that looms over our market and threatens to break the fragile balance that is currently keeping home prices fairly level.

Sunday’s Contra Costa Times reported 40,283 of our neighbors are in mortgage limbo

Tens of thousands of Bay Area homeowners are trapped in a bizarre real estate limbo, living in houses but no longer paying for them, waiting and wondering if someone will help them — or throw them out.

Some are victims of their own economic circumstances, unable to afford their mortgages and expecting to lose their homes if they can’t get breaks from their banks. Others are opportunists, choosing not to spend on a house worth less than they owe. Instead, they can live rent-free until their lender makes a move.

The limbo phenomenon is a radical departure from previous real estate crashes, when there were far fewer troubled loans and banks moved speedily on those who fell behind on payments. Now many lenders simply can’t keep up, and others appear reluctant to flood a weakened market with foreclosed homes.

It all adds up to lingering instability for the Bay Area housing market, as lenders slowly work through the backlog while homeowners endure uncertainty that could last months or even years.

Years are more like it. Remember that the backlog started building in August of 2008 with the first of many moratoria.

An estimated 40,283 homeowners across a seven-county region spanning the East Bay, South Bay and the San Francisco metro area were at least three months behind on their mortgages but not yet in foreclosure as of April, according to CoreLogic, which tracks mortgage performance data. That’s about 4.5 percent of total mortgages in those areas, and a drastic increase from 0.25 percent in January 2007. In the East Bay in early 2007, 1,435 loans were more than 90 days late but not in foreclosure. In April of this year there were 23,155. In the San Jose metro area, the total grew from 513 in January 2007 to 11,558 in April.

These are enormous numbers when you also consider that this only represents a small slice of would-be foreclosures. There are no doubt many tens of thousands more homeowers who have received a NOD but nothing else has happened.

Nationwide “roughly 3.5 million loans are in this limbo land, and are not proceeding through very quickly. It could take years,” said Sam Khater, an economist with CoreLogic, which tracks mortgage performance. “I have a feeling it’s going to follow the path of unemployment and have a long tail.”

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Khater said many lenders are moving slowly because they hope the government will eventually step up to help cover their losses. They also may be hoping an economic recovery will allow many borrowers to catch up with their payments, but “they’re going to be waiting a while,” he said.

The banks are clearly dragging out the process at the direction of the government.  Geithner, Summers, Bernanke, and the rest are orchestrating this slow-down. If any one big bank starting dumping property, the others would jump in to avoid being left holding the bag.

Critics of loan-modification programs say that the housing market would be better served if foreclosures moved more quickly and that any resulting drop in home prices is necessary to reset housing values to their pre-bubble levels. Allowing delinquent homeowners to remain in their homes for months or years means many of the owners will stop maintaining their properties, which hurts their neighborhoods, and their own delinquency may even encourage neighbors to default, prolonging the housing market’s pain, some say.

A better way of critiquing loan modification programs is that they are confusing the cure and the disease. They feel that foreclosures are the disease and stimulus, bailouts, and modifications are cures. But the truth is that excessive debt is the disease. Foreclosures (and bankruptcies) are the cures.

Jobs aren’t enough

There’s another unfamiliar wrinkle in delinquency trends now, said Hans Johnson, who studies housing at the Public Policy Institute of California. Any time unemployment rises, mortgage delinquency does too, he said, just as it has in the past few years. But this time around “even people who are employed are debating whether to keep paying the mortgage because they’re so far underwater,” he said.

New research from consulting firm Oliver Wyman found among borrowers nationwide who defaulted in the first half of 2009 and remained in default at the end of last year, 19 percent could have afforded to keep paying. In June, mortgage financing company Fannie Mae said it would punish such strategic defaulters by prohibiting them from getting a Fannie-backed loan for seven years after their foreclosure, instead of the typical five.

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There’s no survey data on the demographics of nonpaying homeowners. But with unemployment and recession affecting all socioeconomic levels, the nonpaying phenomenon spans poor neighborhoods and rich ones, from tiny condos to multimillion-dollar houses, said Jon Maddux, CEO of YouWalkAway.com. The company provides legal and financial advice to homeowners who’ve stopped paying.

Maddux said defaulting is one way owners have of “lashing back” at lenders when they’ve been frustrated by a lack of response or denial of their loan modification. He rejects the notion that borrowers have an ethical obligation to keep paying, saying mortgages are contracts that specifically include language about what happens if the borrower stops paying.

“We’ve made it so sacred to pay your mortgage, when it shouldn’t be that way. People shouldn’t make their families suffer to pay a mortgage that has an exit strategy in the contract,” he said, referring to foreclosure.

Over the next 2-4 years, social attitude towards strategic default will have a huge impact on Bay Area Home Prices. If walking away from your mortgage becomes socially acceptable in mid-high priced communities, that shift can be contagious. Not only could more people choose to walk away, but people could become much more averse to talking on huge mortgage debts in the first place.

The Contra Costa Times’ figure of 40,283 delinquent homeowners doesn’t mean that all of these people will lose their homes. But if you are a Bay Area homeowner who is falling behind, you can take some comfort from the fact that many of your neighbors are in the exact same situation.