Welcome to Recycle Friday. This week, a post that originally ran on LenPenzo.com, updated for posterity.
If this page appears in your mortgage document, RUN. Also, mortgages shouldn't have sines and tangents in them
Should you walk away from your mortgage just because your home depreciated?
So you refinanced. Or bought too much house. You divided the mortgage payments by your income, and decided you could swing something a few percentage points higher than the recommended 25–33 because the market was rising and your house would make you rich just by existing.
You relied on speculation as an investment strategy (not even your own speculation, but other people’s.) But your house got cheaper, maybe cheaper than what you bought it for. That’s called “losing money on an investment,” which happens all the time, but people think it oughtn’t when your bedroom and kitchen are part of the investment.
The market might bounce back. If you’re 7 years in, lots can happen in the remaining 23 on a 30-year mortgage.
When you lose money on a stock, your brokerage account might get wiped out, but no one will see the evidence of this except you. Owe more than your vehicle is worth, and it might get repoed. Fine, tell people you sold it and always wanted to ride the bus instead. But stop making payments on a house, and there’s a letter from the constable on the door, maybe some yellow tape involved – hard to keep that quiet from the neighbors. Also, people getting forcibly removed from “their” houses (it’s yours and not the bank’s only after you pay the entire mortgage) make for striking photo and political opportunities. After all, bankers are evil. Meanwhile, it’s the working stiffs just trying to make ends meet who get raked over the coals. (Wow, a sentence composed entirely of clichés. Mike Lupica approves.)
Some people who make enough to cover the mortgage dump the house anyway – the strategic default. They assume investment values only move in one direction. According to Experian, that includes 20% of defaulters.
This is hiding behind the law. Stop making payments, and it’s not like you’ll be evicted that week. It takes months, even years. The idea here is to take the mortgage payments and put them toward, say, your credit card balance, figuring the lender will gladly renegotiate a contract you signed in order to get some sort of return on its investment.
Some borrowers think this is fine because if the lender kicks you out, it’ll be tough to sell the house to someone else in a down market anyway. The lender at least wants the house to stay lived in.
This is nonsense. Strategic defaults hurt everyone.
A strategic default does to your credit score what Michael Vick did to underperforming fighting dogs. You’ll never be able to borrow either a) again, or b) until Congress and the White House decide that so many people need to improve their credit scores that it just wouldn’t be fair to let some insidious little 3-digit numbers have such power over those people’s lives.
What’s the solution? Well, no politician of either party wants the other accusing him or her of standing by while old ladies and cripples are being kicked out of “their” houses. The government would then essentially renegotiate mortgage contracts, setting caps on future ones and insisting the lenders take less. Under this type of forced renegotiation, the borrowers don’t even have to sack up and face the lenders themselves.
Besides, co-workers, professors, and the blonde lady on TV say defaulting is fine. And for PR reasons, lenders are hunting down deficient borrowers about as aggressively as the feds go after illegal immigrants.
Say you walk away from your mortgage, mail your keys to your lender, then rent somewhere. Your now-former neighbor follows, then a third. No matter how swank a neighborhood you deserted, the lawns turn brown and the pools green because no one’s living in the houses. Which reduces the value of the remaining houses. Now the people who stayed behind and haven’t (yet) defaulted watch their homes’ values decline. Which means they’ll likely owe more than their houses are worth, making it more likely that those folks will default. Continue like this, and you end up with…Detroit.
When you declare bankruptcy, you can renegotiate to protect yourself from creditors. But strategically defaulting is the opposite – you keep all your assets except the house and mortgage.
So what to do? Four choices:
1. Man up, economize and make your payments. You’re obligated to the lender, yourself (to preserve your credit), any kids of yours (unless you don’t think you need to set an example) and society. If you steal from your lender, it doesn’t directly affect the rest of us, but it makes civilization incrementally more difficult to live in—the broken window theory.
You don’t like that answer? It’s a house, for crying out loud. You need somewhere to live. No matter how much value it loses, it’s still better than renting and never building a dime of equity. Stop assuming that because your $100,000 house lost 10% of its value last year, it’ll lose a similar amount next year and by 2022 will be worth -$10,000.
2. Short sale. If you know you can’t make your payments, and you’ve exhausted every possible way of earning or otherwise securing money, call the lender and come clean AS SOON AS POSSIBLE. The lender will sell the house at a loss, just to get you out of there and collect some money. You’ll still be on the hook until the bank resells the house, but that won’t last forever and at least you can stop throwing good money after bad.
3. Ask for a loan modification. It’s begging, but your pride already left a while ago.
4. The Deed in Lieu of Foreclosure. Tell the lender, “Look, I can’t make the payments. Let’s not short sell, I’ll just give you the damn thing to get out of this suffocating debt.” This hurts your credit rating the least, and tells the lender not to worry about you being one of those evictees who pours concrete in the toilets and makes off with the copper wire.
And next time, get a vanilla 30-year fixed-rate mortgage.
**This post is featured in the Totally Money Blog Carnival-Valentine Edition**
How to invest with inflation still in the distance
Every Friday we review and rework a post we’d written months earlier for someone else’s site. This lets us test our theories, and the content-to-input payoff with these posts is pretty sweet, too.
This is from Consumerism Commentary. Updated notes in blue:
People have feared inflation ever since… well, since the dollar’s last rampant bout of inflation in 1977. However, there’s every reason to believe that this time inflationary pressures are too overwhelming to discount. (The consumer price index rose 1.1% in 2010. In other words, inflation remains low thanks to the Fed’s tight monetary policy. Now if we keep predicting inflation, sooner or later we’ll be right. But for the last 10 months, prices have been even stabler than they were the previous 10 months – when annualized inflation was 1.9%. In short, we were wrong in the short-term.) Or two colossal reasons, at least:
1. Legislative and executive leaders of the federal government, for whom fiscal restraint is a dirty term. No matter how laudable their objectives, they propose to spend and borrow an ungodly amount to achieve them. Any non-politician reading this blog knows the term “regardless of cost” can never be taken literally, but our elected betters think otherwise and aren’t concerned about the inevitable results.
2. A federal funds rate that resembles Carlos Pena’s batting average, or Countdown with Keith Olbermann’s Nielsen ratings. Here’s a really quick primer, because a lot of people act like they know this stuff but don’t:
The Fed (Federal Reserve) is the nation’s central bank. It actually creates our money out of thin air, which it sells to the federal government to conduct its business with. Commercial and investment banks like Chase and Wachovia (whoops. Wachovia, now a subsidiary of Wells Fargo) also borrow from the Fed. The interest rate those banks pay is determined by the Fed and called the federal funds rate, which thus serves as a basis for just about every interest rate in the economy.
Most countries’ central banks set a single rate. The Fed instead sets a range — the more you borrow, the less you pay. This of course favors larger banks, although “favors larger banks” has been a relative term ever since the federal government confiscated $678 per United States citizen and gave lent it to AIG. Since December the range has been 0% to 0.25%, an all-time nadir. (Well, how about that. It hasn’t moved since. And Carlos Pena finished the season at .196, the worst batting average in the majors among guys who qualified for the title.) Inflation has kept pace (see above), barely registering and keeping the dollar’s value intact while jobs disappear. The range eventually has to rise, since it can’t go in any other direction. Once it rises, in concert with the demand for additional dollars that government spending is creating, inflation should ensue.
What does this mean in practical terms? It means getting your assets the hell out of cash, or at least out of U.S. dollars.
(Note: We’ve long advocated quoting the price of a dollar in terms of gold, instead of the other way around. Details here, but suffice it to say that the dollar has lost an annualized 28% of its value since this post first ran.)
The immediate temptation is to shop the world for the currencies the dollar will lose the most money against. There are candidates such as the New Zealand dollar and the CFA franc, but again, your investment will only then be as safe as that government’s fiscal conservatism.
One strategy that goes a step farther is to look at blue chip stocks that don’t trade in U.S. dollars. If the stock’s fundamentals are strong enough, it shouldn’t matter if it’s measured in Swedish kronor, Swiss francs, or almost any currency short of Zimbabwean dollars. Even if a localized bout of inflation causes the stock’s nominal price to artificially rise, its real price should remain consistently strong.
Here are some examples of giant corporations that don’t necessarily trade on the Big Board nor NASDAQ:
Yes, Toyota. Exhale. And while extolling the benefits of a particular security might make the author come across as a boiler room stock promoter, I’m not telling you to buy anything. I’m telling you to look critically at the reasons for a stock’s atypical behavior.
The fun part! What did those stocks do since then?
Let’s start by looking at which ones we chose. One of those companies had some bad if undeserved PR since we posted. That company’s public image would have taken a historic beating, the worst of the year, if another company on the list didn’t have a problem was 1000 times worse. Yeah, BP won’t want to relive last summer anytime soon. We chose these stocks 3 weeks before the Gulf of Mexico disaster, too.)
This is all syncopatic, to use a pseudo-word. We’ve also written at length about what a bargain BP stock is. But that was after Deepwater Horizon.
Royal Dutch Shell, up an annualized 41%.
BP, down an annualized 43%. However, it’s up almost an annualized 100% since its July nadir and continues rising.
Toyota, down since April on the Nikkei but making huge strides since the fall. Here’s the chart. Toyota was trading at 3750 when our exercise began. Prices in yen:
If you think a week of questionable publicity in one market can turn the world’s largest and most respected automotive company into a bad investment, you shouldn’t be investing in anything more demanding than an index fund. A few months from now, no one will remember the recent uncomfortable performance that the parent company of two of Toyota’s major competitors forced the company to undertake.
Furthermore, this is a perfect time to go contrarian. Toyota shares have dropped 20% in the last month. Think about why that might happen to a stock.
Gold is the traditional inflation hedge, but when you see an investment being sold during commercial breaks on general-interest TV shows, that opportunity has clearly evaporated. Besides, gold’s value has quadrupled in the last 8 years. (And has been growing even faster ever since.) That’s swell, but if you’re looking to preserve wealth, remember that time continues to move forward, not backward.
What about Treasury Inflation-Protected Securities, whose defensive strength is written right into their very name? These are a type of U.S. bond whose interest rate, as you can probably figure out, factors inflation in. TIPS are great in theory, as long as you can trust the government’s consumer price index numbers and you can trust the government’s ability to honor its debts. “Full faith and credit of the United States government” doesn’t mean quite the same now as it did when the phrase was coined.
**This post is featured in the Totally Money Blog Carnival 2**