David over at My Two Dollars blogged about whether he thinks it’s okay to walk away from a mortgage. Originally, back in 2008, he said he didn’t think it was okay and was just wrong. Fast forward to today and he has changed his mind. He now believes, in light of all the government support the banks are receiving (and not really passing it on to their customers) that it’s okay to walk away. I completely agree.
I was just talking to my neighbor about this last week. I’ve mentioned him before. He bought the house across the street back in 2006 right at the peak of the market for a sales price of $440K. If he was to try and sell it today, he’d be lucky to get $315K. Fortunately, or unfortunately, he didn’t put much down on the house because he hadn’t sold his previous home. Instead he got two loans. One for 80% of the sales price and another for 20%. That put him at zero percent equity and it’s just gone down hill from there. To top it off, he lost his job about 9 months ago. He has stayed current on his mortgage but he’s taking a long hard look at how much longer he can do that. He also believes it’s okay to walk away, probably more out of necessity, than anything else.
From my viewpoint, the banks offered a loan against a piece of property. By holding the deed to the property they are, in effect, saying, “If you don’t pay this mortgage off, we are going to foreclose and take your house”. Now that it’s happening with increasing frequency (read: A LOT), there is all this talk about how it’s immoral to walk away. I don’t agree. The banks normally go to great lengths to loan to credit worthy individuals. That’s why they invented credit scores. It just so happens that they threw all those rules out the window during the real estate feeding frenzy of the mid 2000’s. It is due to their lack of prudence that they are now faced with taking back hundreds of thousands of homes (as their contracts state). Do I think they should be lowering loan amounts? Nope, not in most cases unless it’s to their benefit to do so. I think they should take the houses back and do their best to minimize their losses by selling the properties. Hopefully, if you are walking away from your home, you live in a state that doesn’t allow deficiency judgements. In these cases, you can’t just simply walk away. You could very well be billed the total loss that the bank takes on the property once they sell it. While there has been some press on this recently, apparently it doesn’t happen too often.
Anyway, in the end, I think that the banks made calculated risks with each of the loans they doled out. They are going to yield a positive return on some of the loans and they are going to lose on others. Don’t get me wrong, there is certainly some personal responsibility that is called for here. Personally, I think where morality comes in to play in all of this is where the people took out loans they knew they could not afford. It was at that point, that they made an immoral dishonest choice. At the same time, had the banks used their very old and very reliable guidelines for lending, these loans probably wouldn’t even have been approved in the first place. The folks that took out loans that they could afford but have since found themselves unemployed or underemployed and now can’t afford to pay their mortgages are really the ones that I completely sympathize with. They made a good faith effort to honor the loan, but now can’t. I don’t think they have a lot of choice other than to walk away, unless they have enough equity to actually sell the house and break even.
Let the flaming begin!
I would suspect that your thoughtful post will generate some amount of (hopefully) thoughtful debate.
That said, I must disagree. In the example of your neighbor, it seems to me that both the bank and the borrow each have contractual responsibility in this situation. It sounds as if your neighbor is considering walking away primarily because of the loss in value of his home. That happens when we buy stuff, whether with cash or via a loan. If I use a margin account to purchase some stock and the value goes down substantially, should I attempt to walk away?
People who are considering walking away from a loan because the home value moved in the wrong direction need to look long and hard at themselves in the mirror. They signed a contract, and in signing that contract have agreed to specific terms. If loss of income prevents them from making the payments, they may not have other options. But to leave because the home value has gone the wrong direction is morally and personally wrong.
P.S. Your comment where you stated “[the borrower] could very well be billed the total loss that the bank takes on the property once they sell it†is a bit misleading. While, as you say, lawmakers have prevented this from happened, the normal process would be that the default amount would be classified as ordinary income to the borrower and taxed accordingly.
Al, you make good points. My understanding of these contracts is that you are signing a commitment to pay and if you don’t follow through on your commitment, the bank has the right to foreclose and take the property. I’m not a huge fan of people making the decision to walk away from houses just because they have negative equity. I certainly have much more concern for the people that have done all they can to honor their contract but, through job loss or other circumstances, can no longer afford to keep paying.
I do think there is responsibility on both sides of the contract. The banks should have done a lot better job enforcing their own rules on lending and the borrowers, in cases where they took ridiculous loan terms that they knew they’d struggle to afford, should have not taken the loans in the first place.
As for deficiency judgements, I think banks know which states allow for deficiency judgements and I would expect they’d factor that in to the rates and fees they charge for the loans up front. Of course, it’s a rather politically charged environment these days where we have politicians jumping in the middle even in states that do allow for deficiency judgements. I think if politicians want to outlaw them in their states, they should do that, but I don’t think it should be retroactive for loans that already exist because that’s unfair for the banks that priced their loans in the first place with the understanding that they could go after the difference on failed loans.
I disagree with Spokane Al. This person has lost his job and so all of the money going to his mortgage is money that is not being spent on other necessities. Furthermore, he’s unlikely to recoup that investment in any reasonable time frame given the fact that he bought at the peak of the market. For someone in that situation, it can make lots of sense to walk away from a mortgage.
Frankly, I think it’s pathetic the way the media tries to shame individuals into needing to live up to their obligations in all situations, come what may. The reality is that businesses are constantly making decisions based on a cost-benefit analysis, and they routinely break contracts when it is in their interest to do so. You don’t hear as much about “contractual responsibility” in those situations. Ditto when they are looking to the federal government for assistance. And the key thing to keep in mind is that by nature, I think that most people who are considering walking away are not doing it as a first resort. Usually they are considering it after significant life events, like a job loss. And in those situations, it can absolutely be the right financial decision.
Sorry if this seems terse — I’m just frustrated with the media holding individuals to a higher standard than corporations. You don’t read as much about responsibility when a company considers filing for bankruptcy so it can reject leases, shed debt and pension liabilities, etc. But for some reason when individuals are between a rock and a hard place everyone wants to get on a soap box about responsibility. As the British say, I think that’s rubbish. You should tell your neighbor to assess the rents in the area and figure out what the pros and cons would be if he walks away. Who knows — maybe he could be your first tenant!
No worries, go ahead and quit paying your mortgage. The rest of us will just work a bit harder to pick up your slack.
Just got my “Honk if I’m paying your mortgage” bumper sticker in the mail last week.
Sure, people walk away from mortgages. However, that then means that banks need to account for that risk in the future and hence mortgage rates will probably increase over time. Should then be ok for the government to step in and then put a cap on interest rates like was recently done with credit card interest rates. Or should banks be able to charge what they consider an “appropriate” amount of interest, based on the increased likelihood that people might walk away from their mortgage.
Alot of this current crisis was obviously the bank’s fault since they did not follow their own rules. But as more people walk away from their mortgages, banks will have to start raising mortgage rates
Finance experts are weighing in on this topic over at LifeTuner: http://www.lifetuner.org/topics/30-owning/discussions/382-in_the_news_walk_away_from_your_mortgage
One of the experts, Tara Nelson, has even written a 13 page white paper on the topic worth checking out.
Interesting anecdote from Iloveshoes. Thanks for sharing. I live in a metropolitan area and know at least two people who I am fairly confident are underwater. Fortunately they are all employed (for now).
I’m somewhat confused why it is as being framed as an ethical and moral dilemma. As mentioned earlier, corporations can do the same when they file for bankruptcy. However, if walking away from a mortgage is going to be a common scenario then it means that mortgage rates have to increase to account for this increased risk. Corporations generally borrow money at a higher interest rates than mortgages. Also, even car loans tend to have much higher interests than mortgage interest rates.
Mortgage rates should be set appropriately which was one of the major issues here with all the “fancy and complicated” mortgages available. Also, one wonders whether the government would want to step into to try to say what an “appropriate” level of interest should be like is now being done with credit card interest rates.