September 3, 2008

Watching train wrecks, part 2.

Five signs of an impending train wreck

Most of the people we hear from or read about have a tendency to either not include enough information about their situation or they do a life history dump and include things that we’d frankly rather not know.

But from some of those, we can tell readers there’s a pattern, and there are several common train-wreck predictors that really shouldn’t be a major surprise to most of us:

Number one is the lack of a reserve. Instead of having 60, 90 or 120 days to respond to whatever situation comes up, in many states at-risk borrowers are usually only a paycheck or two away from not living in their home.

Number two are precipitating events, the most common being a loss of income for any number of reasons, often involving medical factors and combined with job loss. And without the reserve, by the time the income is restored number three has kicked in.

Number three which is often as a result of number two, the at-risk borrowers’ credit is so damaged that they may even have trouble finding a lease or rental property that would allow them to more gracefully exit the property on their own schedule.

Number four includes a propensity to have other consumer debt. We can tell you attorneys in foreclosure mills love to find high-interest auto loans, rent-to-own accounts, high credit-card balances and other default accounts in a borrower’s credit report. No matter what the issue is, the picture is easy to paint that it’s the borrower’s fault, not that of the servicer.

Number five may have been overlooked. Professor Elizabeth Warren pointed this out in her book “The Two Income Trap,” some years ago – you could conclude that children cause bankruptcy. Well, not exactly, but the chances of someone filing bankruptcy increase radically if they have school-aged children. The reason, according to her study is parents have a tendency to take on more home debt than they should to get their children into “better schools.”

So here’s the pattern (it should sound familiar):

  • Parents want to live in a good school district so they go for the house that is really a bit of a stretch beyond even their two-income cushion. Until recently, lenders were more than happy to oblige, even go beyond just encouraging into outright fraud.
  • The too-high house payment puts pressure on other expenses and lifestyle choices don’t adapt to the new conditions quickly enough, hence debt tends to accumulate and there is no chance to accumulate a reserve.
  • Something happens and income is cut or some extraordinary expense comes along. Then the decisions about what will be or won’t be paid get harder.
  • Defaults on one or more things occur, credit scores suffer and they’re trapped. If there is any equity at all they’re the perfect at-risk target for opportunistic collectors and servicers.

We’re surely not alone in seeing this pattern, but we think we’re among the few who see the opportunism at work when the train is nearing the wreck site.

(To be continued)

Craig and Dave

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