Is Negative Equity a “Hardship”?

Fannie Mae provides on its website a Hardship Affidavit for homeowners to use as a part of the HAMP loan modification process. Predictably, the standard hardships are all there: (a) loss of income; (b) loss of job; (c) unemployment; (d) under-employment; (e) the 3-Ds – death, disability, divorce; (f) excessive debt; (f) health issues; (g) interest rate reset, etc, etc, etc.

Noticeably absent from this parade of horribles is “negative equity,” a term becoming more and more common today when describing the current housing crisis. Actually, the term is somewhat of an oxymoron, since “equity” has historically referred to the as-yet unrealized gain that represents the appreciated value of an asset over its purchase price. However, today, negative equity is used to mean that one is “underwater” on their home – that is, either the home’s market value has fallen below its purchase price, or that value has fallen below the unpaid principal balance of the mortgage(s). Essentially, the homeowner has no equity and won’t for the foreseeable future.  In these cases, if the homeowner needs to sell – say to relocate for a new job – there is no alternative except to try to “short sell” the home.   That is, sell it for a price that is less than the total mortgage debt and closing costs.  This, of course, requires consent of the lender(s) holding the recorded mortgage(s) on the home.

And the more negative one is, say 40% “underwater,” the less likely they are to be able to recover anytime soon – assuming that “recover” is used to mean getting out of the red and into the black.

Let’s do some basic math.  Say John and Mary paid $300,000 for their home in 2006.  They put $60,000 down and financed the balance of $240,000.  Assume today the home will sell – if at all – for $200,000.  John and Mary are now officially “underwater” in two different senses: (a) Their home has lost 33.33% of it’s original value, going from $300,000 to $200,000;  and (b) The current market value of their home is at least $40,000 less than their mortgage, not counting the commissions and closing costs, if they were to sell it.

If median housing prices for their area is going up at an annualized rate of  5.00% then their $200,000 home will (theoretically) be “worth” $210,000 in one year.  Using a five year horizon, they can expect it’s value to be $255,000 and change, calculated on a compounded basis by 2015.  But if prices are depreciating at an annualized rate of 5.00% the reverse will occur and their financial plight will be even worse.  At some point, when digging a financial hole, prudent people begin to ask: “When is it time to stop digging?”

Now, doesn’t “negative equity” impose a financial “hardship”?  Of course it does.  And it becomes even more of a hardship when owners prematurely draw money out of their 401Ks, 529s, and other savings funds to meet their mortgage payments – as some of the lenders and modification processors have suggested.

However, in banker-speak, their definition of a “hardship” doesn’t include negative equity…at least when it applies to borrowers. But what about lenders? Didn’t the taxpayers of this country bail them out of the very same types of “underwater” mortgages homeowners are still saddled with today? But rather than calling them “homes with negative equity,” they were called “trouble assets,” as in Troubled Asset Relief Program, aka “TARP” – a not-so-subtle acronym that also refers to a cover to protect against adverse weather conditions.

Specifically, according to the Emergency Economic Stabilization Act, a troubled asset includes:

“…residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability….”

And what was the purpose of TARP? It was to restore liquidity and stability to the financial system so as to:

  • Protect home values, college funds, retirement accounts, and life savings;
  • Preserve homeownership and promote jobs and economic growth;
  • Maximize overall returns to the taxpayers of the United States;
  • Provide public accountability for the exercise of such authority.

Although there is some disagreement whether TARP has met it’s stated goals, there is no disagreement as to who were the primary beneficiaries of  billions of taxpayer dollars – the banks and their holding companies.  In fact, it was so attractive that some very large investment houses decided to secure bank charters, just so they could participate in the largesse, some of which was used to pay salaries and bonuses.

So, back to the issue at hand. From where I sit, homes that are underwater are “troubled assets” and owning them should qualify as a financial “hardship” just as they qualified for relief when the banks were unloading them onto the backs of  American taxpayers.   Considering TARP’s stated purposes (protecting college funds, retirement accounts, and life savings, etc) one wonders why some of the  taxpayer money wasn’t used to bailout underwater homeowners in the first place.  (If the answer is “moral hazard,” “too big to fail,” and similar arguments, I’ll address that in another post.)