Foreclosure Ain't What It Used To Be

The WSJ ran on op-ed claiming that the problem with foreclosures is not so much sub-prime mortgages as it is no-money-down mortgages. The more I think about it, the more I agree. If you have no skin in the game, foreclosure is not so bad.

In the old days, you had to make a 20% down payment; you would probably have to save for years to get enough for the down payment. Then if you lived in the house for a while, you would make substantial progress paying off the mortgage. Your mortgage might be 50% or less of the value of your house. So, if you lost you job and lost your house, you lost a lot of savings. On a $200,000 house, you might lose $100,000 which would represent years and years of savings.

During the housing bubble you could buy a house for nothing down and perhaps get a mortgage that didn't even require you to make full interest payments, so that the principal owed would get bigger as you lived in the house. In addition, because of the income tax mortgage deduction, the government subsidized this arrangement. Because of the income tax deduction and the negative interest payments, you might actually be able to buy a house more cheaply than you could rent a comparable one. But because you have no skin in the game, it's really comparable to renting. You can walk away and lose no more than if you walked away from a rental unit.

Under these conditions, it makes sense to walk away from a house if the payments get to be too much, or if you think they are too high for the house in the current market. You might get a black mark on your credit history, but that's nothing compared to losing hundreds of thousands of dollars that you had saved over decades.

Now the government is trying to prevent foreclosures, based on the old notion of the hardship it caused, when today it causes much less hardship. Many of the people facing foreclosure have just been scamming the system, getting government subsidies for living in houses that they can't afford. Now the government is concerned that can't continue to live in these same houses and is coming up with new subsidies to keep them there. It is a strong disincentive to people who bought their houses the old-fashioned way.

In helping prevent foreclosures, the program should look at how much equity home owners have. If they have negative equity, it's probably more of an indication that they paid no money down and got concessionary interest rates, which means they probably don't deserve to be bailed out. They've just been renting. The government should not go to any great pains to bail them out. But if someone has a lot of equity and is going into foreclosure because he lost his job or had huge health expenses, then some help is merited.