(Dazzie D)
“Homeowners should be walking away in droves. But they aren’t. And it’s not because the financial costs of foreclosure outweigh the benefits. One can have a good credit rating again–meaning above 660–within two years after a foreclosure.” That’s the conclusion reached by a law professor who’s written a paper about strategic default, which is when you elect to walk away from an underwater mortgage because you stand to lose more money trying to keep it than if you cut your losses immediately. The problem is, lots of people think it’s the wrong thing to do, because individuals are supposed to play by different rules than the companies they do business with.
Over at Metafilter, there’s a lengthy discussion about the paper and the concept of assymetrical norms, which is what it sounds like–one party in a transaction is expected to follow a stricter set of rules than the other, and punished by accusations of immorality or poor ethics–usually by peers–if they don’t. The law professor, Brent T. White of the University of Arizona, says this is why too many homeowners don’t act in their own economic best interests. This is the abstract of his paper, “Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis”:
“Contrary to reports that homeowners are increasingly “walking away” from their mortgages, most homeowners continue to make their payments even when they are significantly underwater. This article suggests that most homeowners do not strategically default as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to induce homeowners to ignore market and legal norms under which strategic default might not only be a viable option, but also the wisest financial decision. Unlike lenders, individual homeowners have thus generally not acted to minimize their losses and have born a disproportionate share of the burden from the housing collapse.”
The Washington Post talked to White about his argument, specifically to ask how he can say strategically defaulting might be financially healthier for a homeowner. White notes that some states protect a homeowner’s assets from a lender, while in other states a savvy homeowner might be able to find cracks in the mortgage agreement that open loopholes of protection. (A Loophole of Protection will add +5 to a saving throw against a Deed Troll, as you probably know.)
People on the banking side of things are not impressed by this argument. The funny thing, though, is they don’t provide any good arguments for why such assymetry of norms is a fair and just way to do business; instead they just reinforce White’s basic argument by pointing out how horrible strategic defaulters are:
“Borrowers who walk away from their mortgage obligations face serious consequences” including severely depressed credit scores for extended periods, Fannie Mae spokesman Brian Faith said. In addition, he said, “there’s a moral dimension to this as homeowners who simply abandon their homes contribute to the destabilization of their neighborhood and community.”
Lewis Ranieri, chief executive of several major mortgage-related companies and one of the pioneers of the mortgage securities industry, called White’s entire argument “incredibly irresponsible and misinformed.” Not only is the professor urging consumers to break legally binding contracts, Ranieri said, but if large numbers of them did so it would send home mortgage rates soaring and “tear apart the very basis” upon which mortgage lending rests — the understanding that borrowers will honor their commitments and pay back the money they borrowed.
And yet… if a business finds itself in an untenable financial position, it is considered smart to put a stop to things immediately and, hopefully, go on to fight another day. If only individuals had the same freedom in the marketplace.
“Homeowners! You Have Nothing to Lose But Your Mortgages!” [Metafilter]
“The moral dimensions of ditching a mortgage” [Washington Post]
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Many credit-worthy people are underwater on their mortgages because lenders made loans to folks who were NOT credit-worthy. That practice drove up demand and prices that are now not sustainable due to the inevitable default on the bad loans.
The lenders broke their contract with the public by making bad loans. Why do folks with good credit, but mortgages that are double their home’s value have a higher level of moral obligation to continue to pay on those loans? From a purely economic standpoint, depending on where you live (some regions have experienced greater value drops) your credit score will recover before you will ever see the value of your home approximate the current mortgage.
Continuing to pay on a 30 year mortgage could mean you are ready for social security before you will have a deed to the property that is still worth less than you paid for it. Don’t be guilted into doing something stupid.
Continuing to pay on a house that will never be worth what you owe on it OR choosing to walk away are both life-altering.
My wife and I have had zero defaults ever and never intended to. My credit score when I checked it about 2 months ago was 740 and my wife’s was 720. We both have great paying jobs and are well above the median for the area and live reasonably within our means. We plan on having children in the next year or two and 4 years ago we (maybe foolishly) bought our first house, a 2 bed 1.5 bath condo in a nice, established community in North East Central Florida. We bought for $150k and now, a 3 bed 2.5 bath 6 units away has been on forclosure for 2 years and is now slashed to $49k. The “Obama Plan” (not using that as a political statement, I just don’t care to look up the real name), does not apply to us because we make too much and we have a condo.
About a year and a half ago we got some major leaks in the ceiling and called our association to have them fix it (it’s their responsibility and we are not allowed to hire our own people to work on the exterior). Someone came out, went on the roof, and when they cam back down said all would be fine. Since then, we have repeated this process exactly 11 times. We are responsible for any damage inside the home and our insurance won’t cover it because the leak came through the roof which is the associations “fault” so we have spent approx: $12k in repairs to fix what the leaks have destroyed.
About 5 months ago I discovered mold inside one of the walls where water had leaked in from the leaking roof and that was the straw that broke the camels back. I looked into buying another home and renting this one out but if the mold caused medical problems for the tenants, we could be legally liable. I won’t raise children in this house and I can’t afford two mortgages.
We made the decision to work with a lawyer to strategically default and in order to save ourselves undue financial burden, we are filing a chapter 13. We are acting now because if we wait too long we will also be held responsible for taxes on any possible “forgiven” amount of the deficiency. This was not our first choice, believe me. But for our families financial security(and health) This was the best decision for us. This is more about living a life than worrying about doing what is right in someone else’s eyes. We payed interest the entire time we have lived here (infact, as you all know, most of the payments we made in since we have owned have gone straight to interest) which indicates risk the mortgage company took on in writing our loan. I feel zero sorrow for them or what we are doing and we look forward to moving into our new rental in two months.
This is not about morals, it’s about doing what is right in the long run for your financial security and your families well being and it is all perfectly legal.
What I don’t understand is…when you get your car repossessed, you are liable for the difference between the auction price, and what you owe. So if you owe 10k on a car, and it sells for 5k, you still owe the bank 5k.
So apparently if you walk away from a mortgage where you owe 100k, and the house is worth 75k, you aren’t responsible for the 25k if the bank takes the house back and resells it?
In some states, they can’t go after you if you are insolvent or have lived in the house as an owner for a length of time. Law are being enacted to allow banks to go after investors who buy and bail.
So I’m only on page 12 of 54, but this paragraph sums up this entire case to me, in regards to a professional couple who bought a California home for $550K, no money down and a 6.5% interest rate. The market then collapses, and their home value goes from $560K to $180K, with a comparable mortgage payment (theirs is $4300/month) being $1200/month:
“Assuming they intend to stay in their home ten years, Sam and Chris would save approximately $340,000 by walking away, including a monthly savings of at least $1700 on rent verses mortgage payments, even after factoring in the mortgage interest tax reduction. The financial gain for Sam and Chris from walking away would be even more substantial if they took their monthly savings and put it into an investment account. If they stay in their home on the other hand, it will take Sam and Chris over 60 years just to recover their equity – assuming, of course, that they live that long, the market in Salinas has indeed hit bottom, and their home appreciates at the historical appreciation rate of 3.5%.”
I understand the moral indignation. I am also very offended by this concept…but I think that some folks are missing the professor’s point. He is simply stating that walking away is most likely to be advantageous from a financial perspective to certain upside down homeowners. Whether or not they can afford the mortgage and whether or not they should have ever applied for it is not relevant to that point.
Morals? Not being considered here…and that shouldn’t be a surpsie since he is a professor of law (shower if you got ‘em).
Is it right? No. Are you screwing the rest of us if you do it? To some degree, yes. Should you do it? Well, that depends on you…but let’s set morals aside for a moment and consider just the following purely pragmatic consequences:
- That improvement to your FICO score is not guaranteed…especially if you have been slipping on other obligations, did not have stellar credit in the past, or have also been living in the home without paying the mortgage for some time.
- Even if you get a 660 FICO down the road, that’s still a pretty poor score in the new economy.
- FICO improvement or not, you may find your bank canceling your credit card…and may find it very difficult to get another…outside of pre-paid cards at 7-11.
- Have fun trying to get approved to move into a decent apartment, most of which run credit reports. Ditto getting utilities, a cell phone, a car loan, etc.
- Your job may or may not be affected (security clearance, etc)…but future jobs probably will be…unless you punch a clock. Many potential employers routinely run credit checks on candidates as a measure of reliability and character.
- These consequences may also adversely affect your children and other loved ones.
So yeah, perhaps the guy in the educational ivory tower doesn’t have all the answers…even if you are willing to check your morals at the door.
In the paper (and I’m only 19 pages in), he addresses this. First, you could secure a home to rent prior to defaulting. Secondly, he mentions that anyone doing this must be prepared for bad credit for a number of years, and that planning to walk away from a home potentially requires years of preparation ahead of time.
As to job security clearances and FICO scores: according to a recent report from Deutsche Bank, the number of underwater mortgages is predicted to be a majority of American mortgages by 2011, so even if a minority of those people walked away, that’s still potentially millions of Americans walking away from mortgages. Banks can’t afford to lose millions of creditors, or at least I wouldn’t think so.
This is the hypothetical savings(?) for a professional couple who bought a house during the housing boom for $550,000 ($4300/month) with no down payment and a 6.5% interest rate only to have the market tank, bringing their home value to 180,000 ($1200/month):
“Assuming they intend to stay in their home ten years, Sam and Chris would save approximately $340,000 by walking away, including a monthly savings of at least $1700 on rent verses mortgage payments, even after factoring in the mortgage interest tax reduction. The financial gain for Sam and Chris from walking away would be even more substantial if they took their monthly savings and put it into an investment account. If they stay in their home on the other hand, it will take Sam and Chris over 60 years just to recover their equity – assuming, of course, that they live that long, the market in Salinas has indeed hit bottom, and their home appreciates at the historical appreciation rate of 3.5%.” (Emphasis mine)
Sure, they may get labelled as morally terrible, but they aren’t ruined for lifeby a situation that wasn’t theirs to control from the beginning. Nor does this seem like a couple that was trying to live an excessive lifestyle.
They would be dumb not to walk away.
I tried to post this twice, but it must have been too long. On page 12 of the paper, he mentions that a couple that bought a $550K ($4300/month, no down payment, 6.5% interest) house in Salinas, CA which promptly tanked in value to $180K (1200/month), could save $340,000 and 60 years worth of rebuilding equity if they walked away, assuming a value of $180K and an appreciation value of 3.5% (per year, I assume).
While they may be “morally reprehensible,” no one could fault them for the strategy involved. This move could be the deciding factor if they have a family or not. As the paper states, their bills, plus the $4300 house payment, has them just breaking even. If they took the money that they would be paying on interest and put it into an investment account, then they could begin to gain back their losses.
This doesn’t sound like the tale of a couple buying a house far outside their means; a $550K house in Salinas, CA seems on the low side (from homes.com) in the first place. Secondly, if they moved to a market with lower living expenses, they would have to pay everything involved in relocation, possible months without a job, and possible jobs with lower incomes (not to mention possible underemployment).
Who can fault this? Not I.
I stopped paying for 6 months. Then the next thing you know, I get a loan modification in the mail lowering my payments in half and dropping my interest rates almost below 5%. And no, it’s not an Interest payment only, They refinanced my mortgage for free.
Would a strategic default be a suitable strategy for credit card or home lien debt too?
I took out a lien to pay for some new siding on my house, and the lien came with 12 months no payments and no interest. Half way through the 12 month period, I lost my job and although I’m back working again I’m barely able to make ends meet, especially since the credit card interest rates have shot up. It’s got to the point where I can pay one or the other.
I had considered taking money out of a IRA to pay for the credit card debt, but a strategic default is an interesting option, if it would work.
I just wonder if people have thought about the tax consequences of walking away from their mortgages… I realize that federally one can avoid the tax cost of doing this (but not so much in a lot of states. In other words, some of the defaulted amount is considered income, therefore taxable). However, have people realized they’ll lose that nice tax deduction for mortgage interest? So their tax bill will go up. Therefore I ask the people who are doing this, especially those who can continue paying their mortgages but want out because they don’t want to throw their money away: You don’t think paying high taxes throwing your money away?