Friday, May 16, 2008

How to Default on Your Mortgage and Stay in Your House

(Felix Salmon) Floyd Norris today finds one of the worst bonds ever underwritten: a securitization, by Merrill Lynch, of second-lien mortgages mostly originated by Ownit. The kicker? When the bond was sold, Ownit had already gone bust, a victim of the fact that far too many of its loans were delinquent out of the gate.

But what's bad for bondholders might be good for homeowners.

Let's say you're a Californian who bought your $200,000 house with a $160,000 first mortgage at 6.5% and a $40,000 second mortgage at 11.2%. Your annual interest payments are $10,400 on the first, and $4,480 on the second, for a total of $14,880, or $1,240 a month.

When the housing market implodes, you can simply stop making payments on the second mortgage. As Norris explains:

"In light of the pressure on home prices and limited or negative borrower equity in their homes, many second liens were simply written off" after several months of payments were missed, Moody's said.
With these loans, it turns out, foreclosure is seldom worth the effort, since all the money would go to the first mortgage holder.

With no fear of foreclosure and being kicked out of your house, your monthly mortgage payments have dropped from $1,240 to $867 - a fall of 30%. And that's before you try to renegotiate your first-lien repayments.

It's walking away without walking away: you can default on your second lien, stay in your home, and see a large reduction in your monthly nut. And since you're in California, where mortgages are de facto non-recourse, you don't need to worry about the owner of the second lien trying to get a court judgment against you.

Of course, as Floyd Norris points out, you do give up any upside if and when you decide to sell the house. The second lien is still there, and unpaid interest payments are accumulating: should the house ever get sold, the second lien owner will take anything the first lien owner doesn't. And for the same reason, you'll never be able to use your house as security for a new loan.

Even so, the idea of walking away from a second mortgage seems much more compelling, especially in California, than the idea of jingle-mail, or walking away from a first mortgage. Which is one reason, I'm sure, that this bond of Merrill's is performing so badly.

No comments: