| >> 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... |
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.