Will paying borrowers to pay their mortgage prevent strategic default?

In a sign of extreme desparation, mortgage insurers and lenders are signing up for a new program that pays borrowers to keep paying their mortgage.

Irvine Home Address … 28 GREENFIELD Irvine, CA 92614

Resale Home Price …… $335,000

Pay me my money down

Oh pay me, oh pay me,

Pay me my money down,

Pay me or go to jail,

Pay me my money down

Bruce Springsteen — Pay Me My Money Down

I have long contended that people who are underwater and paying more than the cost of a comparable rental should strategically default. They are pouring their money down a black hole never to be seen again.

Lenders have tried appealing to morality, but unfortunately for them, strategic default has become common and accepted. Their efforts at appealing to morality have failed.

As families strategically default get out from under their crushing mortgage payments and get to keep living in their houses for two years or more, their friends and acquaintances take notice. As others observe the benefits people obtain from strategic default, they consider it themselves. Once people see someone they know and respect strategically default, all moral compunction vanishes.

Lenders have tried incentivizing loan owners to continue to pay by modifying the terms of the loan to make payments more affordable. Most of these programs provide a temporary benefit and increase the balance owed. Their only measure of success is how many additional payments they can squeeze out of a borrower before they strategically default.

The latest effort to keep loan owners from doing what is in their financial best interest is to dangle a carrot in front of the borrower by offering them direct cash rewards if they continue to pay their loan. This has the same desperate quality as car rebates when the automakers pay people to buy their cars. Perhaps in recognition of how bad things have become that crazy ideas like this are actually being implemented, the American Banker magazine is exploring the ramifications of this loan program.

Pay for Performance

By Laura Thompson Osuri — OCT 1, 2011 12:00am EDT

With nearly one-fourth of Americans underwater on their mortgages and home prices still on the decline, homeowners who resist the temptation to strategically default and make efforts at meeting their obligations should be applauded. But should they be paid for it?

Only a banker would think loan owners should be applauded for pouring money down a rat hole.

Loan Value Group, a firm in Rumson, N.J., has been experimenting with the idea. It has a program, called RH Rewards, through which banks, mortgage servicers, hedge funds, insurers—pretty much any institution that carries mortgage risk—can offer a financial incentive to their underwater customers, mainly targeting those who remain current on their mortgage.

Once a customer accepts the invitation to the program, every time an on-time mortgage payment is made, the reward grows, up to a predetermined maximum, typically no more than $20,000. When the loan is paid off, either through refinancing or a sale, the homeowner gets the reward.

The dangling carrot approach. The lender makes a phantom payment to an account the borrower only gets if they pay on the loan until the loan is paid off by sale, refinance or full amortization. For an underwater loan owner, they can't sell, and they can't refinance, so they only way they see this pittance is to keep paying their mortgage for a decade or more until they have enough equity to get out of their property.

Rewarding people just for doing the bare minimum, for following through on promises made of their own volition, feels unsettlingly un-American somehow.

No, abdicating lender responsibility and unleashing a Ponzi scheme which dramatically inflated house prices feels unsettingly un-American. Making the bankers eat their losses and bear the consequences of their foolishness feels settlingly just.

I am amazed at the mindset of these bankers. This article was written for their consumption. They really believe that debt is as American as apple pie, and the terms of a promissory note are moral obligations. Perhaps widespread strategic default will get them to reconsider their attitudes and actions, but I doubt it.

But RH Rewards also borrows from that most American of ideas—using financial incentives to drive desired behavior. That's a concept that has been used in programs to encourage everything from good grades to healthier lifestyles.

Bribery is a very old concept, but I hardly consider it American or desirable.

In the case of underwater homeowners, establishing rewards for on-time payments is a way to replace incentives for a group whose original payment motivation has been lost.

A group whose original payment motivations has been lost? LOL! That is the best euphemism I have read in ages. The group they are talking about was motivated to pay as long as prices were going up and they were given more Ponzi debt to make their payments. Once the HELOC money was not forthcoming, they lost their motivation. ~~ giggles to self ~~

“It's a clever way to create a mutual benefit between all parties involved,” says Sayta Thallam, director of the financial markets group at the free markets-leaning Mercatus Center at George Mason University. “It's essentially changing the terms of the mortgage, and people do that and refinance all the time. You can't begrudge your neighbor because he refinanced and got a better deal.“

Yes, you can. In fact, it's relatively easy to begrudge your spendthrift neighbor who got this deal because they borrowed themselves into oblivion with reckless HELOC abuse. The prudent get screwed while the imprudent get rewarded.

While the reward will not be enough to make up for the negative equity a homeowner has, Frank Pallotta, a managing partner of Loan Value Group, is confident that that the program, particularly the extra $100 or so up for grabs each month, is enough to make someone rethink a strategic default. “The reward is not intended to put someone 'in the money,' but is more of a 10-year light at the end of tunnel,” Pallotta says.

The incentive is too small and too far off in the future to have much effect. Ask any employer who has put together an employee benefit program. If the incentives are not tangible and obtainable in a reasonable period of time, employees do not respond, neither will borrowers.

While Loan Value Group operates all aspects the program, it does not provide the cash incentive. That's where partner companies come in. There are eight so far, with the latest one, PMI Group, signing up in early July. The Walnut Creek, Calif.-based insurer says it will role out the RH Rewards program to customers in the Florida and Arizona first, and will decide from these results whether to offer the program on a larger scale.

Mortgage insurers are the ones with the most to gain by buying time. A mortgage insurer is on the hook for the losses from strategic default. As the party assuming this risk, they have the most incentive to pay people to keep paying their mortgages.

Loan Value Group touts that RH Rewards is used in 40 states, offering more than $113 million in rewards covering $1 billion of mortgages. Pallotta says that partner mortgage holders have been able to reduce defaults rate by 50 percent through RH Rewards, with nearly all the invited homeowners agreeing to participate in the program. The default rate among those in the program is “under 5 percent,” he says.

This program hasn't been going long enough to know if it really cuts down on strategic default. Further, a 5% default rate is still atrocious. Most borrowers who sign up for this program have likely already decided not to strategically default for whatever reason, so for them, this is just free money for doing what they would have done anyway. Why not sign up?

Still, this is a very small piece of the $14 trillion mortgage pie. And it provides rewards to only a select group of underwater homeowners, leaving millions of others dutifully paying their mortgages with no cash incentive.

Yes, one billion out of a 14 trillion dollar market is very small. Also, it would be interesting to know the criteria they used to select their borrowers. I doubt they were picking Las Vegas borrowers who owe $300,000 on their $120,000 homes.

But Alex Edmans, the Wharton finance professor who developed RH Rewards, hopes the program will gain traction with some of the larger banks and mortgage servicers, and that the most distressed homeowners will be moved to the head of the line.

“With anything, you first offer the program to those who have the greatest need for it,” Edmans says.

In his paper last summer outlining the RH Rewards concept, Edmans referenced a statistic from the National Bureau of Economic Research showing that 31 percent of foreclosures in March 2010 were strategic, up from 22 percent a year earlier. More recently, a report from Moody's in July noted that the risk of strategic default is rising among performing mortgages as loans-to-value ratios, a strong predictor of future default, “are now approaching the LTV of loans that have defaulted since 2009.”

Dean Karlan, an economics professor at Yale University, says that with such unusually high rates of strategic defaults, banks are acting like any other troubled retail business, scrambling to find a way to keep some wayward consumers (homeowners) interested in their product (mortgages). “They are just tinkering with price to find the profit maximizing point,” Karlan says.

That is exactly what they are doing. If they pay out a few incentives but keep a few extra borrowers paying, they will make more than what they pay out.

“Consumer firms do that all the time with coupon and sales,” Karlan notes. “We do not live in a world in which everyone pays the same price for the same service.”

There is no justice in finance, and finance professionals are okay with that.

California Housing Finance Agency gets stiffed

The California Housing Finance Agency has been featured on the IHB twice before. The first was when they implemented their $2 billion loan owner welfare California initiative. The second was when they announced they wanted to give money to HELOC abusers. Today we are going to look at one of their bad deals here in Irvine.

This property was purchased on 6/21/2007 for $469,500. The owners used a $455,657 first mortgage and a $14,085 second mortgage to cover the down payment. The buyers put nothing down. The borrowers defaulted, and the California Housing Finance Agency bought paid off the first lender with a $478,584 payment. They are now looking to lose about $150,000 on the liquidation.

Idiots.

——————————————————————————————————————————————-

This property is available for sale via the MLS.

Please contact Shevy Akason, #01836707

949.769.1599

sales@idealhomebrokers.com

Irvine House Address … 28 GREENFIELD Irvine, CA 92614

Resale House Price …… $335,000

Beds: 3

Baths: 2

Sq. Ft.: 1267

$264/SF

Property Type: Residential, Condominium

Style: One Level, Contemporary

Year Built: 1982

Community: Woodbridge

County: Orange

MLS#: P797311

Source: SoCalMLS

Status: Active

On Redfin: 1 day

——————————————————————————

SPACIOUS FLOOR PLAN WITH BRIGHT LIVING ROOM, COZY FIREPLACE, OPEN KITCHEN, 3 GREAT SIZE BEDROOMS WITH LOTS OF CLOSET SPACE, 2 FULL BATHS, NEW CARPET IN BEDROOMS, NEW INTERIOR PAINT AND MUCH MORE. ASSOCIATION AMENITIES HAS POOL, TENNIS COURT, AND BBQ, GREAT FOR A STARTER FAMILY.

——————————————————————————————————————————————-

Proprietary IHB commentary and analysis

What exactly is a starter family? So now we have starter homes for starter families?

Resale Home Price …… $335,000

House Purchase Price … $469,500

House Purchase Date …. 6/21/2007

Net Gain (Loss) ………. ($154,600)

Percent Change ………. -32.9%

Annual Appreciation … -7.8%

Cost of Home Ownership

————————————————-

$335,000 ………. Asking Price

$11,725 ………. 3.5% Down FHA Financing

4.10% …………… Mortgage Interest Rate

$323,275 ………. 30-Year Mortgage

$104,824 ………. Income Requirement

$1,562 ………. Monthly Mortgage Payment

$290 ………. Property Tax (@1.04%)

$0 ………. Special Taxes and Levies (Mello Roos)

$70 ………. Homeowners Insurance (@ 0.25%)

$372 ………. Private Mortgage Insurance

$414 ………. Homeowners Association Fees

============================================

$2,708 ………. Monthly Cash Outlays

-$244 ………. Tax Savings (% of Interest and Property Tax)

-$458 ………. Equity Hidden in Payment (Amortization)

$17 ………. Lost Income to Down Payment (net of taxes)

$62 ………. Maintenance and Replacement Reserves

============================================

$2,085 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$3,350 ………. Furnishing and Move In @1%

$3,350 ………. Closing Costs @1%

$3,233 ………… Interest Points @1% of Loan

$11,725 ………. Down Payment

============================================

$21,658 ………. Total Cash Costs

$31,900 ………… Emergency Cash Reserves

============================================

$53,558 ………. Total Savings Needed

——————————————————————————————————————————————————-

42 thoughts on “Will paying borrowers to pay their mortgage prevent strategic default?”

  1. octal77

    New lingo for Irvine HELOC’d hipsters:

    original payment motivation = instant gratification from ever rising home prices.

    current payment motivation = What, me worry?

  2. awgee

    You and others keep saying that lenders have been trying to appeal to morality to encourage borrowers to continue paying, but I have not seen any evidence of this. Where do you see this?

    1. IrvineRenter

      We could start with Hank Paulson’s finger-wagging speech back when the credit crunch hit. We could follow that with the hundreds of mainstream media stories where incredulous reporters and interviewees were aghast at the idea people would choose to stop paying their mortgage.

      I know you do not believe borrowers should strategically default, but if you don’t believe lenders have appealed to morality to get their loans repaid, you have not been paying attention to mainstream media stories, nor have you been reading your own comments about people keeping their word.

      1. awgee

        I have never said that I do not believe borrowers should strategically default. Other’s decision are neither a belief nor a judgement for me to make. I have said that my integrity depends upon my holding to my word. I have been paying attention to the mainstream media stories and I have not seen evidence of lender appealing to morality for borrowers to pay. Can you provide any of these mainstream stories? I seriously doubt that I have said anything about others keeping their word, and I think that I have referred to myself in that context. If I have referred to others, I think I have probably said that they have to look at their own conscience to make their decisions.

        Sorry, I do not remember Hank Paulson’s speech, but I believe you know what you are talking about. I do not remember reporters begin aghast or judgemental, but I do remember them being surprised at a new behavior which is entirely different.

        2. lunatic fringe

          “I have said that my integrity depends upon my holding to my word.”

          I don’t understand how this applies to paying a mortgage each month when the contract says you will pay the mortgage each month or the collateral will revert to the lender. The contract distinctly says you have two choices here:

          1. Pay the mortgage and keep the house.
          2. Stop paying the mortgage and let the lender take it back.

          When your contract says you have choices, what’s wrong with taking the option that is the best deal for you?

          1. awgee

            I am not so sure the mortgage contracts I have signed in the past say that I have two choices. I think it reads more like I promise to pay the mortgage. If I don’t pay the mortgage, the bank will foreclose.

          2. DarthFerret

            I definitely see 2 options in your statement above. You should read your own statements more carefully.

            -Darth

          5. New Irvine Home Buyer

            In countries that have debtors prisons (I grew up in one):

            Your two choices are :
            1) Pay the mortgage and keep the house
            2) Stop paying the mortgage, let the bank take it back and send you to prison.

            You have two choices, and there is nothing wrong with taking the option that is the best deal for you. 🙂

            On another note, in the country I grew up, when people were unable to pay their debts, they found a hidden third option.

            They fled the country:

            http://www.nytimes.com/2009/02/12/world/middleeast/12dubai.html

            Nothing immoral in that, they picked their option. There is nothing moral or immoral about making a loan, or defaulting on a loan, or paying it back. It’s all business. Sometimes its a crime. However, your credit worthiness is judged based on how often you choose the 1st option, or as awgee put it … “keep your word”.

          6. awgee

            As in my other example:

            Lindsay Lohan promises to the judge to not use cocaine. The judge says great, but if you do use cocaine, you will go to jail. Lindsay uses cocaine and goes to jail. Did she break her promise to the judge?

            Is one’s word a matter of consequence convenience? Or is it one’s word?

          7. awgee

            Yeah, that’s it. Don’t you ever get tired of making the most ridiculous and stupid fallacious arguments? Do you and PR really think that people do not see through them?

          8. Legal Freak

            1. The word “promise” is never used in a mortgage contract
            2. The borrower is allowed to default, and the bank is allowed to foreclose in that case.
            3. The bank is not mandated to foreclose. The bank has the option to foreclose.

            This is not that complicated.

        3. awgee

          IR – I read all the articles you posted. It appears to me that there is a lot of finger pointing that the government and lenders are saying that borrowers have a moral obligation, but no one is actually citing the government officials or lenders. It looks like a bunch of hearsay. The was one college professor who said he thought it was immoral, but that is a far cry from “hundreds of mainstream media stories where incredulous reporters and interviewees were aghast at the idea people would choose to stop paying their mortgage.” I think you are exaggerating immensely and the overwhelming tone is one of non-judgementalism and explanation of the various issues. A couple of times folks accused Obama of saying that one has a moral obligation to pay, but they do not cite him. Maybe he did say, may he did not, but I would not assume so. Most, if not all the articles, just report on the opinions of different people. Mostly, they generally refer to a portion of the populace that feels they are morally obligated to pay.

          Multiple accusations of government and lenders saying that people have a moral obligation to pay is not the same as government and lenders actually saying it. And the more I read, the more I doubt that your accusations of same are accurate.

          My guess is that quite the opposite is true and that politicians are being quite careful is what they say about non-payers. I think you are letting your own opinions cloud your judgement as to what is actually being said. You even said that I believe that borrowers should not strategically default and I highly doubt that is true or accurate, but is rather your own perception based on your own bias.

          1. DarthFerret

            no one is actually citing the government officials or lenders. It looks like a bunch of hearsay

            So you’re saying that the argument that borrowers have a moral obligation to choose only the contract options that best suit their lender is a flimsy, poorly-defended, and unconvincing argument?

            We agree!

            -Darth

          2. awgee

            Hearsay is information gathered by one person from another person concerning some event, condition, or thing of which the first person had no direct experience.

    2. SantaAnaRenter

      Because they like to point out that the NOTE always says “promise” to pay…

      What they leave out – paraphrasing here – is “promise to pay or you can take the collateral (house)”.

      Therefore, NOT paying is simply allowing them to execute on that part of the contract… It’s “business” and if they take a loss then they shouldn’t have loaned 100% to an unqualified borrower to begin with.

      1. awgee

        If I promise to fulfill a particular behavior, by promise is not a promise if there is a consequence to my not fulfilling my promise.

        If Lindsay Lohan promises not to snort cocaine to the judge, and she gets busted for snorting cocaine and goes to jail, did she make a promise or not?

        Is one’s word dependent upon the outcome, or is one’s word just one’s word? Is integrity situational?

        1. awgee

          “If I promise to fulfill a particular behavior, by promise is not a promise if there is a consequence to my not fulfilling my promise.”

          should read:

          If I promise to fullfill a particular behavior, is my promise not a promise is there is a consequence to my no fulfilling my promise?

          and I will add:

          If a consequence is attached to a promise, does that make it not a promise?

          Is one’s word only good if there is not a consequence attached?

          1. awgee

            Sorry I can neither type nor proof read. Please forgive and let me try again.

            If I promise to fullfill a particular behavior, is my promise not a promise if there is a consequence to my not fulfilling my promise?

            I read it four times and think it is correct?

        2. christian

          I would have a hard time going through life with that set of moral standards, if I made a late payment it would be an affront to my character because I promised to pay on time, But that is just me.

  3. wheresthebeef

    Reading this article made me cringe. These little carrots being dangled by the lender is nothing more than drug dealers giving away some occasional freebies just to keep their clients hooked. The drug dealers know the small upfront out of pocket cost is peanuts compared to the long term financial benefits they will receive.

    I sure as hell hope not one cent of this bribe money is tax payer money!

  4. Nevada Joe

    Does anyone in this blog chain actually read?

    First of all, let me say that I was one of the early receipients of the Responsible Homeowner Reward last year. The number was substantial enough for me to stay. I grilled the bank as to why I was getting this “reward” (I was late only once in two years), that they said theywanted to reward those responsible homeowners for doing the right thing.
    Second, don;t get caught up in the language of the contracts. Society can not and will not go after strategic defaulters for more reasons than I can write here. So drop it.
    Third: The Program works, folks. If my bank was able to lower default rates by 50% at a cost that is far less than the alternative; then I want to be a part of that bank. To be clear, a bank MUST hedge against the risk of default – strategic or not. You’d be an idiot if you didn’t buy home or car insurance.
    Fourth: Financial incentives in the US have been working for more than 200 years. Buy a book, and step away from your angry Blog world. Or better yet: google “financial incentive theory”. Enjoy.

    I was offered money NOT to walk away when it might not have been in my families best interest to do so. We stayed, my bank paid, and gues who won? I did, the bank did, and the neighborhood did from me not abandoning my house.

  5. Swiller

    Are there two awgee’s posting? Has alzheimer’s kicked in if it’s the same person? Has awgee had a close enoucnter with Jesus?

    No idea, but here’s a post from awgee that explains his position quite clearly:

    2011-09-15 11:24 AM
    It may be a bit gray, but that does not change the morality of going back on your word, and the grayness is a strawman argument. The defaulters know whether or not they can still pay. They know whether or not they are scumbags.

    If you have not LOVE, you have nothing. We all need to show more compassion, unless you want the same judgment back on you. Awgee, I wouldn’t wish for you to be in the position of millions of americans, even though I KNOW it would bring understanding and compassion from you.

    1. awgee

      Yes, I said THEY know. It is not for me to say or judge.

      And I have been in that position. I have been upside-down on my mortgage, and I know exactly what position they are in and how they feel.

  6. IndyLew

    I am sure I saw that Chase bank had a “cash rebate” mortgage program about oh…a year ago advertised in one of those lobby displays. The interesting part is that they claimed they either patented or trademarked it so that no one else could ever offer rebates for timely payment etc. So the idea isn’t new to mortgages, and I thought the idea that Chase could get intellectual property protection on the entire idea, to be as absurd as much else that goes on in banking. That, and it was ridiculous to think some buyer can’t figure out that the rebate isn’t worth the higher interest. That, and I realized, most borrowers are as ignorant or stupid as Chase thought in its heavy advertising of this “concept” enough to think that the tiny rebate matters more than the huge monthly payment (look to the number of Americans who purposely overwithhold tax so they will get a large refund check, huge numbers).

  7. newbie2008

    MarketWatch That’s because, starting Oct. 1, the maximum size of loans that can be guaranteed by the government controlled Fannie Mae and Freddie Mac drops from a maximum of $729750 in high-cost markets to a maximum of $625500. Also, many borrowers who previously … UPI.com Wall Street Journal (blog) CNN

    Maybe this will release some of the hot gas in the bubble.

  11. ChicagoWalkAway

    But what is a loan owner supposed to do when the bank refuses to foreclose after non-payment of the mortgage?

    Mind you, the loan owner is still responsible for the home….

  12. Roland Estrada

    The people below, Aliso Viejo officials, are losers, should be fired and ridden out of town on a rail. These Nazis are the ones responsible for draconian open house sign rules in place in Aliso Viejo.

    They waste tax payer dollars by having someone like Ted Halsey (Building Official), drive around in his personal car on weekends and steal open house signs off of street corners. All at a moment in time where cities can’t afford to wasting money. And I’m sure this clown is making overtime to boot. I caught in the act of sign stealing on Sunday afternoon October 2nd. He told me he must have around thirty signs in his car.

    These jokers cost must cost agent thousands of dollars per year in signs and wasted time. They also are doing a disservice to the homeowners who the bills and the salaries of these trolls. I’m sure the city can figure out a better way to spend the people’s money.

    Mayor: Carmen Cave
    Mayor Pro Tem: Donald A. Garcia
    Council Member: Greg Ficke
    Council Member: William “Bill” Phillips
    Council Member: Phillip B. Tsunoda

  13. boom

    Promises go to many people: The companies promised that they would try really hard to make good investments so that their investors make a good rate of return on their stocks, bonds, etc. Investing in 100% collateral loans, assuming homes values always go up, not verifying income was all bad business judgement. So who are they to talk about taking the moral path?

  14. boom

    When you purchase a home, a bunch of promises are made:
    Your promises:
    1. you will pay on a monthly basis for the home
    2. If you cannot, your home will be taken from you and all payments you made are not reimbursed.
    3. Sometimes, the bank sells the home for more, depending on the state, you don’t always get your equity back.

    Banks Promise:
    1. They will use their expertise to check title, check appraisal (their collateral) and make sure the home is worthy of their investment.
    2. They will collect the money and adjust your principle until it is fully paid in a fair manner.

    What happens when the banks that make these promises are the same banks that make investment decisions (mortgage backed securities, loose appraisals, lack of proper corporate oversight) that lead to a real estate bubble that reduces your home values and put you in an upside down position? Did they live up to their portion of the bargain? I think this is a very complex moral question and not easily answered. There are multiple variables. Ultimately, people make choices based on their circumstances. No one makes a strategic decision and blow up their credit if they have the cash. That would be incredibly unwise. 95% of the people who make these decisions either are DEEPLY upside down, lost a job, or have to make a decision between shelter they can no longer afford or food for their family. The guy who speaks about keeping his words has probably never been squeezed enough in life to have a very real moral choice.

  17. newbie2008

    Is FL a non-recourse state? Where the loan seconds?

    Are the banks using a judicial foreclosure to get around the non-recourse non-judicial foreclosure?

    Does FL have a “reclaiming period” for the former owners to buy back the property?

Comments are closed.