People often fall in love with their homes based on some charming but impractical feature or other. Now, increasing numbers of homeowners are abandoning their nests for similarly emotional—and sometimes irrational—reasons.

It turns out that many of the Americans defaulting on their mortgages are doing so out of anger, fear or despair rather than making a purely sensible decision about their best financial interests, a new study found.

But that isn't always the case. It depends on the cost of alternative housing and on future home-price movements, which are hard to predict. Also uncertain is how many years a borrower may need to repair a credit rating and whether the lender may try to collect any amount by which foreclosure-sale proceeds fall short of the loan balance.Brent White, an associate professor of law at the University of Arizona who ran the study, focused on "strategic defaults" in which a borrower who could afford to keep paying opted not to do so. That phenomenon is frequently described as a rational response by homeowners who are "underwater," owing far more than the current values of their homes.

Strategic defaults are becoming more common, various studies show—a Morgan Stanley report pegged them at 12% of all home-mortgage defaults in February, up from "insignificant levels" three years ago. Lenders fear borrowers who "walk away" will greatly increase the industry's foreclosure-related losses, which already total in the hundreds of billions of dollars.

Defaults are more likely to be strategic among people with higher credit scores and loan balances, Morgan Stanley found. That may be because people with higher credit scores typically have more money and thus can decide whether to pay rather than simply defaulting when they run out of cash.

Most people continue to pay their mortgages even when they are underwater, Mr. White noted, adding that "the stigma against default apparently remains robust." Many borrowers don't seem even to consider strategic defaults until they have "greatly depleted or exhausted" their savings, Mr. White said.

But Mr. White also sees a "contagion effect," in which people become more likely to default strategically if they know others who have done so.

Loan-modification programs are supposed to provide hope but sometimes "actually fuel the hopelessness and anger" of borrowers, because these programs "seem designed to wear homeowners down," Mr. White said. Borrowers often can't get banks to respond to their questions and are repeatedly told to send in the same documents.

To give more underwater homeowners an incentive to stay put, Mr. White suggests a "rent-based loan program" setting monthly payments in line with the cost of renting a comparable home. That would give borrowers a sense that they are paying a fair price for shelter, rather than "throwing their money away" on a home in which they may never have equity, he said.In addition, lenders typically offer reduced payments only to homeowners who have defaulted or are considered likely to do so imminently. That angers people who have borrowed more conservatively and kept up on their payments but now "feel unfairly left out while the 'less deserving' get help," Mr. White said.

Before the air escaped from the Manhattan real-estate bubble, a mix of art, culture and design was often the centerpiece for marketing many expensive condominium projects.

Now, brokers say, buyers are turning their backs on such gimmicks. Instead, they're rediscovering basics: location, square footage, ceiling heights and solidly built with what brokers call "good bones."

Nowhere has the shift been more visible that at 650 Sixth Ave., a handsome, 19th-century stone-and-brick loft building where condominiums went on the market in 2007 after conversion from offices.

Instead of celebrating the interior cast-iron columns or the neo-Renaissance arched windows, Michael Shvo, the building's hard-charging broker, captured the moment with a marketing campaign built on what he called "white-box gallery living."

But sales stalled. The developers tried another broker, then another and finally, in March, a fourth. Now the building has been rebranded and relaunched as a neo-Rennaissance classic tinged with history and tradition. Sales have rebounded.

Now they want to see the finished product and know whether they can get a mortgage before they sign on the dotted line. "You can no longer sell a dream," said Dolly Lenz, a broker at Prudential Douglas Elliman, "and you can't get financing for a dream."The story of 650 Sixth in many ways reflects what is now a bygone era. Buyers used to have confidence in a rising market, and were willing to put down hefty deposits on the strength of a floor plan, a celebrity architect and a high-fashion designer.

Mr. Shvo, in an interview. said his concept for the project was "always a good one." Sales stalled, he said, because of delays in completing the renovation and problems in quality and finishes that were amplified because of the white-on-white asthetic.

In the beginning, Mr. Shvo envisioned 650 Fifth as an artsy building for the aspirational elite. There was art gallery space in the lobby. The condo units carried the white theme from bleached white oak floors to the white Poggenpohl cabinets.

There were also white glass backsplashes, white counters, white furniture and cold white walls, providing a perfect backdrop for an art collection.

The space was a "blank canvas," Mr. Shvo said at the time. All buyers needed to do was add their own art.

There was an early burst of contract signing, but when sales stalled in 2008—even before the collapse of Lehman Brothers that triggered a sales freeze in many buildings—Mr. Shvo was succeeded by Corcoran Group, and then by Prudential Douglas Elliman.

When a fourth sales team was hired, Mr. Shvo's high-minded concept was finally reined in: In model apartments, the floors were stripped and darkened with walnut stain. Walls were repainted a warm white. The white cast-iron pillars became metallic gray.

And, three years after Mr. Shvo launched the project, a white wall was even repainted a different color—a warm brown for accent.

Shaun Osher, the head of Core, a Manhattan-based brokerage that now has taken over sales at the project, said the original marketing campaign was like "oil and water" in trying to be artsy while ignoring the appeal of an unusual, landmark building and the surrounding Chelsea neighborhood.

"It wasn't about all the things that a buyer should be thinking about," he said.

"It was about fancy, shmancy marketing. This is a beautiful loft building. It needs to be celebrated as such."

Mr. Shvo still thinks his idea for the building was solid. "There is nothing more difficult to build than white space," he said.

Mr. Shvo was one of a group of marketers who, during the boom years, borrowed a page from fashion and cosmetics marketing to sell new condominiums as lifestyle choices that prized culture over mere brick and mortar, stone and glass.

The 650 Sixth building was purchased by Penterium, the residential development unit of a Korean company, Kumkang Housing Corp., for $70.5 million in 2006. El-Ad Properties, the developer of the Plaza Hotel, had purchased it a year earlier and flipped it for a 50% gain.

Mr. Osher's conservative reimagining for the building also included renaming it as the Cammeyer, for A. J. Cammeyer, who operated a shoe store there in 1897. That historic detail is featured in the Landmarks Preservation Commission's report on the property.

When Mr. Shvo's firm left the project in 2008, he said that 35% of the building's 67 apartments were under contract. Property records show that so far only 20 units have closed, including some that went under contract after Mr. Shvo left.

Now, eight more are under contract, Mr. Osher said.

Refinancing home owners are putting money back into their home at record levels to help plug the equity drain.

On par with the cash-in share, the report showed that the share of "cash-out" borrowers who did the opposite and increased their loan balance by 5 percent or more during the same period was also at a record low, 27 percent.One in three borrowers, 33 percent, who refinanced their loan in the fourth quarter of 2009, lowered their principal balance, the highest "cash-in" share since Freddie Mac's quarterly Refinance Report began tracking the refinance data.

The last record low cash-out share was 33 percent during the second quarter of 2003, just before the last housing boom began.

The data is the latest available from the Freddie's refinance report, but home owners are expected to continue the trend in the soft economy.

"The cash-out loan has been steadily heading towards extinction as funding for this once popular consumer-spending-friendly loan has fallen to the lowest level since 1985 as consumers struggle to restore their household balance sheets," said Nancy Osborne, chief operating officer of Erate.com, a Santa Clara, CA-based financial information publisher and interest rate tracker.

When a home owner completes a cash-in refinance, he or she takes a check to the closing. That can help a home owner surface an underwater mortgage -- a mortgage balance that's larger than the home is worth.

It can also free up more equity for a rainy day, make the home easier to sell and, in some cases, give a boost to the credit score, due to the smaller mortgage balance.

Once home value appreciation sufficiently resumes, the cash-in could also be considered an investment with a better return than other investments.

It's a very smart place to put money in tough economic times.

In a cash-out refinance, on the other hand, the home owner walks away with a check and that drains equity out of the home.

"This transformation from a cash-out refinance market to a cash-in refinance market is consistent with other data we've seen on households reducing their overall debt burdens, particularly revolving credit like credit cards," said Frank Nothaft, Freddie Mac vice president and chief economist.

All refinancing borrowers are also enjoying near record low interest rates, which make a refinance easier to achieve and cheaper.

During the last quarter of 2009, mortgage interest rates dropped to a record low of 4.71 percent for conforming, fixed-rate, 30 year mortgages and averaged 4.9 percent. During the first quarter this year, rates averaged 5 percent, according to Freddie Mac.

"One-half of borrowers who refinanced their conventional loan during the last quarter of 2009 lowered their annual mortgage interest rate by at least 0.9 percentage points below the old rate. For families that paid down their mortgage balances when they refinanced, the monthly payment savings are even greater," said Nothaft.

In addition to boosting equity, some refinancing home owners also bring money to the table to avoid mortgage insurance (required on loans with a loan-to-value greater than 80 percent) and to avoid higher jumbo loan rates.

The shift from cash-out to cash-in loans isn't always due to financial foresight.

"Falling home prices as well as the virtual disappearance of no-cost loans (no point-no fee loans) have contributed greatly to the cash-in trend," Osborne added.

Home owners attempting a refinance for a lower rate, find their home doesn't appraise as high as they thought. The extra cash is necessary to qualify for the refinance.

"The main causes of the decline in cash-out refinance are declining home prices in many areas of the country that have eliminated equity that could have been extracted and tighter underwriting standards for loan-to-value ratios. Among the refinanced loans in our database, the median appreciation of the collateral property was a negative 2 percent over the median life of the prior loan of 3.6 years," explained Amy Crews Cutts, Freddie Mac deputy chief economist.

The massive St. Elias Church on a quiet, tree-lined street in Greenpoint, Brooklyn, features an unusual sign in its front yard: "Live/Work Mansion for sale."

Developer Herb Hirsch has been trying since January to sell the 141-year-old brick behemoth, seeking $7.1 million for the 23,881-square-foot property. He's also willing to break it into two pieces; $3.4 million for the sanctuary and $3.7 million for a Sunday school section.

"We've had some people who were serious," said Mr. Hirsch, who bought the property in 2007 for $3.5 million, according to PropertyShark.com.

Joe Buglewicz for The Wall Street Journal

St. Elias Sunday school area.

"It's obviously a very unique property for someone who's an artistic sort of person or a Wall Street type guy who made way too much money and really wants to live in a grand style." he said.

With paint peeling on outdoor window frames and from the sanctuary ceiling, selling or developing St. Elias might prove to be a task as Byzantine as the church. A few celebrities such as actor Mickey Rourke and wealthy foreigners such as India's "hugging saint mother" Mata Amritanandamayi have eyed the property, but walked away before making a deal.

"It will cost you a mansion to fix up!" said Anna Lewicki, a Greenpoint resident who occasionally attended St. Elias before the church closed in 2006.

She said she's pleased the developer plans to keep the historic façade and has approval from the city Landmarks Preservation Commission to convert the building.

The building started as a Dutch Reformed Church of Greenpoint and became a Catholic worship place affiliated with the Greek rite in 1942.

"The elderly people were dying," according to Ms. Lewicki.

She said many Slavic people left Greenpoint over time and younger people either stopped going to church or started going to the Roman Catholic Church of St. Anthony around the corner.

Mr. Hirsch hopes Greenpoint's recent ranking by pollster Nate Silver as the fifth-most livable neighborhood in New York turns up someone interested in features like a bell tower with views of Manhattan, mahogany church pews and a dramatic choir loft in the Sunday school room.

Joe Buglewicz for The Wall Street Journal

Street view

Musician Pat Metheny used the Sunday school space in the desanctified church between November and January to develop his new album Orchestrion, which features dozens of robotically connected instruments. "It was a total joy to be there for a few months," Mr. Metheny said through a spokesman.

Representatives for Ms. Amritanandamayi, known as Guru Amma, confirmed that the group is looking to expand with a center in New York but didn't say why they passed on the St. Elias property. Mr. Rourke couldn't be reached.

Taxes alone are roughly $50,000 a year for the St. Elias property and buyers are unlikely to get a traditional mortgage for such a building.

"It really needs to be a cash deal," said Christine Blackburn, a real-estate agent at Barak/Blackburn Group, affiliated with Prudential Douglas Ellimen. "We haven't found that kind of financing."

If the building doesn't sell as a mansion, Mr. Hirsch said he's prepared to develop the church into several condominiums.

He would need to finalize renovation plans with the city but already has approvals from the Landmarks Commission to excavate a dirt-floored basement for duplexes, to add roof terraces and to alter some stained glass windows.

Joe Buglewicz for The Wall Street Journal

Detail of a painting in the church's sanctuary

His Staten Island-based architect, Alfred V. Saulo, said that sort of renovation could cost $3.5 million to $4 million for all those upgrades and to put in steel beams, concrete floors and other infrastructure needed to turn the massive church into residences.

"It's a pretty comprehensive undertaking," said Mr. Saulo.

There's an outside chance Mr. Hirsch would sell or develop the building as a commercial space, requiring re-zoning on the property.

Around the country, old churches have opened as community centers, businesses as well as bars, night clubs and breweries. The St. Elias church already has a wooden bar tucked away in a corner of the basement.

When Brooklyn Boulders LLC opened in September, the rock-climbing business's owners purposely left a Daily News logo above its entrance, hoping the facility's former identity as a delivery-truck garage for the New York newspaper would help draw visitors.

"The character and history" of the property definitely make the business more marketable, says Stephen Spaeth, one of Brooklyn Boulders' three co-owners. Several New York publications, including the Daily News, ran stories that mentioned the start-up's original occupant.

Business owners often find unique ways to repurpose buildings: They've transformed jails into hotels, roller rinks into retail shops and churches into restaurants. Many credit their establishments' incongruent past in part for their success.

Those looking to take up the strategy can potentially find bargains as other businesses shutter and leave attractive properties behind. Office and retail property prices in the fourth quarter were down 31% and 26%, respectively, from two years ago, according to Moody's Investor Services Inc. And some properties may qualify for tax credits if they're designated historic.

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Roger delaCruz

The owners of Brooklyn Boulders left the Daily News logo on the facility, saying it would add character to the business.

But investing in a property can require a significant chunk of cash, and financing remains difficult to obtain. "It's the Catch-22 of all real estate today because you've got property you can acquire at extremely low prices, but the parties you usually go to for financing are running in the opposite direction," says Tom Kirschbraun, a managing director at Jones Lang LaSalle Inc., a real-estate services firm based in Chicago.

Realtors say they are seeing some bargains. A vacant New Orleans office building constructed in the early 1900s was sold last month for $5.5 million, about $2 million less than what it was appraised for in 2005, says Richard Juge, president of RE/MAX Commercial Brokers Inc., based in Metairie, La.

The buyer, Mark Wyant, owner of a local small construction business, says he plans to turn the building into a luxury hotel while maintaining its original architecture, including granite and scrollwork exteriors.

The property qualifies for between $3 million and $5 million in state and federal tax credits because of its historic status, says Mr. Wyant.

To buy the Charles Street Jail in Boston in late 2007, where the Boston Strangler and other criminals were allegedly once held prisoner, Dick Friedman says his small real-estate development firm, Carpenter & Company Inc., teamed up with an investor and tapped equity, $15 million in state and federal tax credits, a bank loan and personal savings.

The 150,000-square-foot luxury inn, which includes a restaurant and bar, now makes about $40 million in annual sales, according to Mr. Friedman. "People are fascinated with its history," he says.

But renovation costs on a property originally designed for another purpose can add up. Brooklyn Boulders' Mr. Spaeth says it cost about $1 million to fix up the delivery-truck garage, which is leased, and Liberty Hotel's Mr. Friedman says the total tab for transforming the 169-year-old formal penal facility—including the cost of the property—was about $120 million. "It's not for the faint of heart," says Mr. Friedman of doing a major overhaul of a property. "But I think it's worth it."

Mary Liz Curtin and Stephen Scannell's furniture and gift shop, Leon & Lulu LLC, used to be a roller rink and Motown concert venue. They bought the place in 2005 for $750,000 and added $255,000 in renovations.

They kept the 69-year-old property's original flooring, benches, trophy cases, scoreboard and signage. On weekends and during special events, employees skate through the aisles to serve coffee and cookies to shoppers.

Last year the Clawson, Mich., company posted about $2 million in sales, a 20% increase from 2008, according to Ms. Curtin. "We get letters from people who thank us for keeping the history alive," she says.

Business owners can sometimes run into problems obtaining basic operating permits, warns Alan Shor, president of the Retail Connection LP, a retail real-estate firm based in Dallas. Any business "that might impact children, traffic or even the look of the neighborhood" could face opposition from local lawmakers, he says.

Steve Morrison, who owns Mission Restaurant, a Syracuse, N.Y., eatery housed in a former Wesleyan Methodist church that was an alleged stop on the Underground Railroad, ran into such a problem. A local law prohibits the sale of hard liquor within less than 200 feet of a church—an active one—and he's within that range of a Baptist church. "I can only sell beer and wine," he gripes.

An establishment's idiosyncratic past may not always be an advantage. Hair stylist Randy Fotia says he usually avoids mentioning that his salon was once a funeral home unless clients inquire about a photo on the cash register showing its original facade.

"Some people get creeped out by that," says Mr. Fotia, who purchased the Highland Park, N.J., property in 1992 at a below-market rate with a mortgage he's long since paid off. "I've always liked it."

Mr. Fotia says he spent close to $500,000 renovating the salon, now called All Is Vanity, and the apartment above it, where he lives. Clients are typically unaware when using the bathroom in the basement that bodies were once embalmed down there. "People say they've gotten weird vibes," says Mr. Fotia. But "no ghosts."

You may have noticed the lines at home-improvement stores getting longer or heard the whirring of buzz saws in your neighborhood. After years of economic recession and housing-market malaise, people are starting to fix up their homes again.

 

 

According to an April 15 report from the Joint Center for Housing Studies at Harvard University, annual spending on remodeling is expected to accelerate this year, with nearly 5% growth over 2009. "This year could produce the first annual spending increase for the industry since 2006," the peak of the housing boom, says center director Nicolas P. Retsinas.

But the forces driving today's action couldn't be more different from those during the boom. Back then, people wanted to renovate their places so that they could trade up to bigger homes, or because their home equity was soaring and they wanted to reinvest some of the spoils.

Now, the opposite is happening: Many people who bought during the boom years are accepting the reality that they won't soon be swapping up for a sybaritic spread. Their mortgages may remain above water, but after years of falling home prices, their equity is so low that the transaction costs of buying a new house would leave little for a down payment.

 

 

In short, they are stuck.

"People have seen their down payments kind of wiped out," says Harvard economist Jeremy Stein. "They are locked into their house. They can't really move, even if they thought the other house was cheap and a good deal."

So these people are making their homes more comfortable for a longer-than-expected stay. Setting aside old calculations of how much a particular improvement will add to resale value, they are making smaller tweaks that can make a big difference in livability. You might call it "psychological return on investment."

Nowadays, say real-estate agents and contractors, smaller projects like updating kitchens and baths and humble attic-bedroom conversions are more popular, while two-story master suites and $100,000 kitchen blowouts are decidedly out of fashion. Hidden improvements like insulation also are on the rise, as people realize they won't be able to pass on their drafts, leaks and other problems to the next guy. Tax credits that expire in 2010 are enticing people to make energy improvements, too.

One of the most cost-effective improvements, say contractors, is removing a wall to create an open kitchen-dining area. The project "makes the kitchen feel bigger and the kitchen and dining room more usable," says Sarah Susanka, an architect and author of "The Not So Big House" book series. "It's such a simple thing to do." It can cost as little as a couple of thousand dollars, according to David Merrick, a home remodeler in Kensington, Md., but can run much higher if plumbing and electrical work are involved.

A surprising number of people fall into the category of being above water on their mortgage but anchored to their property. According to First American Core Logic, at least 24.5 million borrowers in the U.S. have home equity of less than 25%, and of those, 13.2 million are above water. Considering the 9% in commissions and fees that typically come with buying and selling a house, as well as the typical 20% down payment on the new one, it is easy to see why people aren't house-hopping like before.

This applies even to affluent professionals. Paul Sorbera, an executive recruiter in Greenwich, Conn., is seeing it firsthand among his clients. He says many financial-services executives "bought $2 million homes in the good times and have $1.3 million houses now because of the price decline. They have some money in the bank and can afford their current living standard, but moving is very impractical for them."

Economists, whose models often assume the rationality of hypothetical consumers, say remodeling makes sense for such people. "If they don't have a lot of equity in their houses and can't move, they should have a propensity to improve rather than move," says Richard K. Green, director of the University of Southern California's Lusk Center for Real Estate. "When you renovate, you save a lot of transaction costs."

Web sites such as Remodelormove.com offer calculators to help consumers make the decision.

Kate Anderson, 42 years old, of Sunnyvale, Calif., a technical writer and homemaker, and her husband, Scott, 43, a vice president at Hewlett-Packard (NYSE: HPQ, News), say they considered buying a larger place to accommodate their growing children, a daughter, 10, and son, 8. But they surmised that buying and selling now would be too expensive. "We didn't think it was worth the whole sale purchase expense … just to get a few extra square feet," Mrs. Anderson says.

Instead, they opted to fix up their 1950s-era tract home, worth an estimated $750,000. Most houses in their neighborhood with new kitchens and baths sell for up to $850,000, she says. While their home "is a little squished," they chose to "gradually improve it," she says.

In December, the Andersons remodeled their kitchen, putting in hardwood floors, cherry cabinets and stainless-steel appliances, ripping out a closet and expanding a doorway to improve the flow. They also installed new incandescent ceiling lights and under-cabinet fixtures, which Mrs. Anderson says she especially loves.

Because they made no major structural changes, they kept the cost to about $50,000, a bargain in the pricey Silicon Valley market. It wasn't easy to hew to that budget, though; the couple decided to ditch a garden window over the sink and self-closing drawers, which would have added several thousand dollars to the cost.

Even in the ever-grander suburbs outside Washington, people are thinking smaller. A few years ago, Mr. Merrick, the contractor, says, more people were doing two-story additions, and most people who remodeled kitchens made them larger. Now, "four of the last six kitchens I did, the footprint stayed exactly the same," he says.

Home-improvement retailers are seeing a clear trend toward smaller renovations. Craig Menear, executive vice president of merchandising at Home Depot (NYSE: HD, News), says there has been strength recently in projects involving simple décor updates such as ceramic tile, interior paint, faucets and bath fixtures. At Lowe's (NYSE: LOW, News), customers were drawn to products to update flooring, cabinetry and countertops during the last few months of 2009, the most recent period for which data are available, spokeswoman Maureen Rich says.

Part of the reason, of course, is money. With home prices slumping, there is less equity for homeowners to tap. An April 20 survey by American Express (NYSE: AXP, News), the first of its kind, found that 72% of affluent homeowners planned to make improvements to their houses in 2010. But they expected to spend an average of just $11,500. And most respondents planned to pay for their projects with cash; just 16% planned to use debt.

Banks also are making credit less available than they used to. Keith T. Gumbinger, vice president of HSH.com, a mortgage-data firm, says that before the housing bust, banks would often lend for projects based on the value of the house after completion of the project, but they are less likely to do so now because "there's no guarantee the improvement or the market will lead to price appreciation." The result: even affluent homeowners aren't able to borrow as much as they used to.

With little reason to expect huge price gains in the housing market in the next few years, some homeowners are thinking especially long-term. Diane Ausavich, a remodeling contractor in Milwaukee, says a pair of physicians, as part of a bathroom renovation, recently installed a barrier-free, walk-in shower and higher countertops in their three-story lakefront home built in the 1890s. They did it "so that as they get older they can wheel in and out with a wheelchair if they should have to," Ms. Ausavich says. The homeowners are in their mid-40s and, "being doctors, I'm sure they see the gamut," she says.

Likewise, Marge Kumaki, 57, a marketing and public-relations consultant who resides in Silver Spring, Md., says she and her husband decided to do some basic upgrades on the post-World War II split-level home they have owned for 21 years after their two children left the nest for good in 2007.

She says she would prefer to move to a new high-rise condominium in downtown Bethesda, but that they decided to stay and renovate because it is more cost-effective and they like where they live now. Last summer's severe thunderstorms, which flooded their finished basement and required repairs, spurred them to get started.

Ms. Kumaki says they are planning to spend in the low $30,000s to update the upstairs bathroom, kitchen and family room.

But the couple have decided to hold off on another dream. "I've always wanted an addition, since it is a split level and you can go up or down," she says. "I'd like another level on top, but that's the future."

The New Remodeling Rules

During the bubble, homeowners sought the biggest, splashiest home improvements to boost resale value. Now they're doing smaller projects that deliver a similar result for far less money.