[TuringNYC]

>> In the US it's more or less impossible for the loans to be worth "nothing".

Totally disagree. A loan can absolutely be worth nothing, especially if it is a 2nd/subordinated lien.

Imagine you buy a house for $1000 with $800 borrowed ($700 first lien, $100 second lien.)

If the home goes down in value 30%, the second lien is worthless. The administrative and legal cost of recovering the second lien may be greater than the recoverable value of the second lien, which in this case is $0.

[timr]

You're describing a situation where the second lien is underwater. This is not itself the value of the loan.

Just in the obvious case, if the borrower continues to pay, the lien is worth the future value of its cashflows. Not everyone who goes underwater on a loan simply stops paying.

In the US, even loans in default tend to have some value, because speculators are willing to buy the debt and attempt collection.

[TuringNYC]

>> You're describing a situation where the second lien is underwater. This is not itself the value of the loan.

Correct, but once underwater, an default renders the loan worthless.

Underwater+Default --Usually--> Worthless 2nd lien

>> Just in the obvious case, if the borrower continues to pay, the lien is worth the future value of its cashflows. Not everyone who goes underwater on a loan simply stops paying.

Totally agree, but not everyone has a choice (divorce, lost job, floating rate rises, wages fall, etc.)

>> In the US, even loans in default tend to have some value, because speculators are willing to buy the debt and attempt collection.

Yes, for recourse states, not for non-recourse states because the later only offers the liquidation of the home as collateral and nothing else. https://www.quickenloans.com/learn/the-difference-between-re...

[timr]

> Correct, but once underwater, an default renders the loan worthless.

Incorrect. A loan in default can usually be pulled out of default, or otherwise re-structured to keep the borrower current. They are not worthless. In fact, there's a whole sub-industry devoted to this called "special servicing". Even for underwater loans, people tend to want to repay their loans.

You are directionally correct that as a loan gets further into default, it loses value, but this is not a step function, and it certainly doesn't happen instantly on default. You're over-indexing on an exceptional outcome from an exceptional time -- even in 2008, the vast majority of distressed borrowers weren't walking away from their loans.

[danielmarkbruce]

Then, just take the example and imagine they declare bankruptcy. That loan is going to be worth 0 in the vast majority of cases.

Loans go to zero. It happens in real estate, it happens in oil and gas, it happens in other places I'm sure. It's not especially common, but it happens.

[TuringNYC]

>> Then, just take the example and imagine they declare bankruptcy. That loan is going to be worth 0 in the vast majority of cases. >> Loans go to zero. It happens in real estate, it happens in oil and gas, it happens in other places I'm sure. It's not especially common, but it happens.

It is common, but at the end of a cycle. The chances of second lien loans being worth zero are higher and higher as leverage increases. This is for two reasons:

1. The greater the leverage, the smaller the required downturn to turn everything underwater. With 5% down mortgages, a 5% decrease in housing values makes you underwater (esp once you consider transaction fees.)

2. The greater the under-water, the less incentive owners have to continue paying, especially in non-recourse jurisdictions where no bankruptcy is required. Owners do "jingle-mail" where they mail the keys to the bank (figuratively) and walk away without having to declare bankruptcy. The bank is left with the mess.

Freddie Mac is already pushing to do 2nd lien HELOCs (https://www.housingwire.com/articles/freddie-macs-proposed-h...) and Fannie is considering it.

[HeyLaughingBoy]

> the less incentive owners have to continue paying

People keep saying this, but the only time they can come up with examples are when the owner wants out of the property. In the case of a home loan, being underwater is meaningless if you're not going anywhere. Most people will continue to pay because they need a place to live. I have yet to hear of someone who was underwater on their primary home loan and decided to stop paying it and default just because. For an investment property I could see that happening. For the house that you plan to live in for the next 20 years? No.

[TuringNYC]

>> People keep saying this, but the only time they can come up with examples are when the owner wants out of the property. In the case of a home loan, being underwater is meaningless if you're not going anywhere. Most people will continue to pay because they need a place to live. I have yet to hear of someone who was underwater on their primary home loan and decided to stop paying it and default just because. For an investment property I could see that happening. For the house that you plan to live in for the next 20 years? No.

Only if you have a real choice. Reasons people will default:

- Divorced, force seller; especially common as finances go downhill

- floating rate on 2nd mortgage/HELOC is no longer affordable

- Lost job, have no money to pay mortgage. defaults

- Job change with lower income. Have money, but not enough to keep up with payments

- property taxes re-assessed, no longer affordable. tax liens pile up on home

[creer]

Fair for 2nds. yes.