What is Shadow Inventory and how might it hinder the housing recovery?  How could it affect you?

Below are excerpts from an article in Whidbey Island Real Estate’s blog called: Distressed and Troubled? These Loans May Crack.  Click on the title for the full article.

get your eggs lined up

There is a great fear that  the shadow inventory will stymie the housing recovery.

What is shadow inventory? There are many definitions.

1st definition – Foreclosed but not listed.  Some analysts say the “shadow inventory” is the homes which the has bank foreclosed on but not sold.  These are homes that are not on the market but owned by the bank (REO’s not listed on the market).

2nd definition – Homes in the foreclosure process as well as delinquent mortgages where foreclosure proceedings are imminent.

3rd definition – All homes delinquent, short sales not on the market, REOs not on the market, and anything in the foreclosure process.

4th definition – All of the above plus modified loans (as they have a large percentage of failing anyway, pay option-arms about to be reset, and lots sitting idle with builders in trouble.

If you go with definition 3, which is what I and many of my colleagues go with,  then naturally your focus is to look at delinquency rates which are widely published.  So to say we have no way of knowing the true size of the shadow inventory is false.  The mortgage banker’s recent survey with data ending in the 4th quarter shows that 9.47% of all loans are delinquent.  That’s a scary number; however the number was down slightly when seasonally adjusted.  Also according to this recent survey 50% of all past–due mortgages were 90 days or further past due.  This is the highest number in the history of the mortgage banker survey.  Usually you’d see a large glut of 30-day past-due balances, which becomes smaller at the 60-day mark, and there would be smaller yet number of 90-day balances (assuming homes were being liquidated with efficiency).  Confused yet?

With fewer loans at the 30-day mark, it seems the glut of sub-prime loans is being flushed through the system but only so slowly that it is creating the large inventory (the 90-day past due loans).  The government and banks are trying loan modifications, short sales, and foreclosure work outs to reduce these properties flooding the market.  Unfortunately distressed assets are distressed assets, especially when they have negative equity.

Standard & Poors sees this shift in lender strategy as temporary as lenders will realize that these toxic assets are unredeemable in most cases.   Therefore these homes, estimated at 33 month’s supply or 5-7 million, will eventually hit the market.   If they do, home prices could head lower because of increased inventories.  The saving grace for the market could the limited new home construction, recent loss in builder confidence, a growing economy, and continued political pressure on banks to keep foreclosure as a tool of last resort. Do you think there is nothing to worry about?

The good news is, there is great pressure on the banks to work with owners to work out, modify, short sell, or salvage these loans in some way.   This being possibly a good sign of that with the B of A offer.    So I guess we can hope that lenders will work with these 5- 7 million asset holders, and find a way to keep people in their homes, and the economic recovery trucking along.