Strategic Default: Inconceivable Assumptions Suddenly Conceivable

Until recently it
was generally believed that only a small fraction of Americans would
willingly choose to skip their monthly mortgage payment, aka “strategically default”, when they
found themselves stuck in a negative equity situation.

The logic driving this belief was based on the notion that borrowers wouldn’t want to damage their credit profile or deal with the social stigma surrounding a public foreclosure. The assumption that most underwater borrowers will
continue making their monthly payments (absent a life event) is factored into the
analytics of risk managers, buyers and sellers of mortgage related assets,
servicing managers, and regulators across the country.

What if this
assumption is wrong? Is that inconceivable?

It wasn’t long ago when conventional wisdom
convinced us that lenders would never make loans to borrowers that had
virtually zero likelihood of being able to pay the loans back. In a 2010 study conducted
by the Cato Institute,
it was estimated that there were over 27 million Alt-A and subprime loans in the
system by mid-2008. That’s approximately 50 percent of all loans in the market.  Remember when we thought home price would never fall on a national level? Never been done and won’t
ever happen, right? That assumption was shattered when home values nationally
dropped between 30-50% from their peak in 2006, wiping out roughly $7
trillion of home equity in the process.

Fannie Mae recently published it’s latest National Housing Survey
and exposed disturbing patterns and sentiments with American homeowners. For
example,  46% of borrowers are “stressed” about their underwater
mortgage, up from 11% in June 2010. That’s an alarming four-fold increase in
three quarters. That statistic becomes even more concerning when viewing the sheer number of borrowers faced with negative equity. At the end of 2010, which doesn’t include the home price declines seen in 2011, CoreLogic estimated that 11.1 million homes, or 23.1 percent of all homes with a mortgage, were underwater. Think about those two stats this way – every morning, 46% of the estimated 11.1 million underwater borrowers wake up and debate why they should
keep paying their monthly mortgage payment. Further weighing on borrowers is that  47% of borrowers surveyed reported higher household expenses than the year before…

From that perspective, it doesn’t seem inconceivable that our assumptions might be off base again. Is principal forgiveness the answer?

Probably not, and here’s why.
Remember how many folks HAMP was supposed to save by giving them new loan
terms? The number touted by the
administration was over 4 million. In reality, the number is likely to come in
around 500-750,000 permanent modifications. Imagine the scenario when a
government sponsored principal reduction program is announced. Out of the 11
million underwater borrowers – you’ll probably get three times as
many borrowers applying for relief. Maybe one tenth of them will actually
qualify and be granted a principal reduction. In the meantime, some 20+ million
applicants would have stopped making payments to “qualify” or be
considered for qualification. How many of them will be able to or even want to
get current again after they are turned down? 

Like it or not, we have got to find ways to stabilize home prices, reward responsible behavior among existing homeowners,
and encourage home buying. I don’t
see any ideas on the table that would accomplish any of these objectives…. and the effects are starting
to show up in data.

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Mortgage Rates Steady At All-Time Lows Thanks To Europe And The Fed

Mortgage Rates are steady to slightly improved today following as Europe’s fiscal woes continue providing downward pressure on US interest rates.  The forces at work keeping rates low were joined today by “minutes” from the most recent FOMC meeting.  All told, several notable lenders are offering their all-time lowest interest rates while others remain close.  

Markets actually got off to a shaky start as far as rates were concerned.  Had it not been for the European headlines and the FOMC Minutes, we’d likely be looking at slightly higher rates today.  Mortgage-backed-securities (aka “MBS,” the most direct influence on mortgage rates) and US Treasuries began the day in weaker territory until news that the European Central Bank had ceased it’s normal interactions with several Greek banks, and the ECB President essentially wasn’t willing to bend over backwards to make sure Greece stays in the Euro-zone.  We discussed the implications of a Greek Euro-zone exit in yesterday’s post.  

The ECB-related news helped bond markets bounce back into stronger territory and FOMC Minutes added to that momentum.  Though there were no major surprises out of the Fed, the Minutes indicated that the Fed remained in sort of uncertain territory with respect to further quantitative easing, which thus far, has been a major boon for rates.

Markets were perhaps guarded against the possibility that the Minutes would indicate a shift AWAY from an accommodative stance.  The fact that the minutes did no such thing, combined with the consideration that this meeting took place BEFORE the most recent bout of Euro-drama was enough for markets to infer a slightly economically bearish bias from the Fed, and the Fed combats economic bearishness by keeping rates low.  

For only the 3rd time since early February, the Conventional 30yr Fixed Best-Execution Rate is arguably straddling 3.75% and 3.875%.  Some lenders’ rate sheets are structured such that 3.75% is clearly Best-Execution.  More have moved down into that territory, though many remain at 3.875%.  (read more about Best-Execution calculations)

Until and unless mortgage rates actually break into NEW all-time lows (which they are very close to doing), we’ll likely keep reiterating that which has already been said:

We see two diametrically opposed forces pushing and pulling on mortgage rates here at these key levels.  The European component is the obvious force pushing rates down, but less obvious is the underlying structure of the Secondary Mortgage Market providing resistance to moving lower.  The latter is what has prevented rates from getting any lower now and in the past.

That said, if the economic outlook remains fairly dim and if European concerns continue to fuel that “flight-to-safety” demand for long enough, the Secondary Mortgage Market CAN slowly evolve to accommodate lower rates.  It remains to be seen whether or not it will actually happen.  Global economic panic is not our favorite justification for thinking rates will move predictably lower.

Investors in the secondary mortgage market have demonstrated that they tend to feel the same way, having clearly avoided a quick move down into uncharted territory with respect to the “buckets” on the secondary mortgage market.  Read more about “buckets” HERE.  Without a more stable motivation for low interest rates, we’d expect ongoing progress in creating a market for even lower rates to continue to be slow and small.  


  • 30YR FIXED –  3.75-3.875%
  • FHA/VA -3.75%
  • 15 YEAR FIXED –  3.125 edging down to 3.00%
  • 5 YEAR ARMS –  2.625-3. 25% depending on the lender

Ongoing Lock/Float Considerations 

  • Rates and costs continue to operate near all time best levels
  • Current levels have experienced increasing resistance in improving much from here
  • Rates could easily move higher or lower, but given the nearness to all time lows, there’s generally more risk than reward regarding floating
  • But that will always be the case when rates operate near all-time levels, and as 2011 showed us, it doesn’t always mean they’re done improving.
  • (As always, please keep in mind that our talk of Best-Execution always pertains to a completely ideal scenario.  There can be all sorts of reasons that your quoted rate would not be the same as our average rates, and in those cases, assuming you’re following along on a day to day basis, simply use the Best-Ex levels we quote as a baseline to track potential movement in your quoted rate).

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Florida Loan Officer Pleads Guilty in $6.5 Million Mortgage Fraud

Alejandro Curbelo, aka Alex Curbelo, a loan officer for Great Country Mortgage Bankers in Miami, pleaded guilty on Tuesday to complicity in a mortgage scheme that cost the Department of Housing and Urban Development (HUD) $6.5 million.  Curbelo, who will be sentenced in June, may receive up to 20 years in prison on a single count of conspiracy to commit wire fraud.

According to charges brought in the U.S. District Court, Curbelo was involved in the sale and financing of units at two Miami condominium complexes.  He admitted that he conspired with others to create and submit false and fraudulent Federal Housing Administration (FHA) mortgage loan applications along with documents that made it appear that borrowers who were unqualified for mortgage loans due to insufficient income, high debt levels, and accounts in collection were competent borrowers.  Curbelo and others also offered the borrowers cash back after closing as an incentive to purchase the units and did not disclose the payments on the on the  application documents.  After the loans closed the borrowers defaulted on the FHA guaranteed mortgages and which went into foreclosure.   FHA had to take title to the units and reimburse the lenders.

The fraud occurred over a period from February 2006 and July 2008 and was investigated by the HUD Office of Inspector General as part of the Miami Mortgage Fraud Strike Force.  Curbelo was charged with wire fraud because he paid the loan closing costs on behalf of the borrowers via interstate wire. 

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Mortgage Rates Suffering From Low-Volume Market Movements

Mortgage Rates
suffered their worst losses of the week today as light volume and low participation left sellers in control, driving benchmark interest rates higher.  When we talk about “sellers,” it’s in reference to sellers of fixed-income securities in bond markets.  The Mortgage-Backed-Securities (MBS) that most directly influence mortgage rates are part of the broader bond markets and tend to move in the same direction as the most popular bond: 10yr Treasury Notes.  When sellers outnumber buyers, prices get lower and lower, bringing yields (aka: interest rates) higher.  This is happening fairly rapidly for Treasuries, but to a lesser extent for MBS (and consequently lender’s rate sheets).  Best-Execution 30yr Fixed
rates STILL haven’t moved higher, but closing costs are quite a bit higher at many lenders today.

What we said yesterday: “Low volume and year-end lack of participation continue to distort
movements in the secondary mortgage market.  The lower a market’s
volume, the more weight carried by those who participate meaning that
it takes fewer trades/less money to move things around.  In
general, MBS (mortgage-backed-securities) have pitched and rolled less
(for better or worse) than their Treasury counterparts.”

Please make sure to read the
“important rate disclaimer” at the bottom of the page in considering
what “all-time lows” means.  The issue of “buckets” as described in the
lock/float considerations below, remains a factor that may prevent rates
and/or fees from moving significantly lower in the short term.


  • 30YR FIXED –  3.875%
  • FHA/VA -3.75%
  • 15 YEAR FIXED –  3.375%
  • 5 YEAR ARMS –  2.625-3.25% depending on the lender

Lock/Float Considerations

The paragraph below is unchanged (except to update “today” to “yesterday”) because it’s exactly what we’d choose to say today.  One other consideration is this: even though we can look at rates suffering here today and be somewhat dismissive in saying “sure, costs are higher, but it’s just due to low volume,” doesn’t mean that something meaningful won’t have come along by the time volume picks back up that actually DOES justify current levels.  In other words, being able to chalk the weakness today up to low volume is only going to make you sound smart in explaining things to friends whereas ACTING to PROTECT yourself might actually make you feel smart if rates do happen to move higher in the new year.  We’re not saying that will necessarily be the case, simply that 3.875% is still the best-execution rate, it’s been historically tough to move much lower, and we probably won’t have a solid idea whether or not that will continue to be the case until the new year.

As noted in the previous post, in many regards yesterday was essentially
last trading day of the year.  Despite the predisposition toward
volatility at times like this, rates have been holding admirably
steady.  Even so, the ongoing low volume environment through the new
year still constitutes more of a risk than a benefit as far as Mortgage
Rates are concerned.  To be clear, we’re not saying any
fundamental negativity is sweeping over the interest rate landscape,
simply situational risk.  Keep in mind that rates are about as low as
they’ve ever been and moving more than .125% lower from here will not be
easy or fast.

Happy Holidays and we’ll see you next Tuesday


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