Mike the Mad Biologist

Yes, You Can Walk Away from Your Mortgage

I’ve made this point before–if your mortgage is underwater, you should consider a ‘strategic default’ (which is what it would be called if you were a business), and, unless you were speculating, it’s not unethical to do so. First, you didn’t force the lender to give you the money (and to the extent that there was fraud, it was usually the lender who enabled it–ninja loans, for instance). Second, since housing loans are traded as commodities, there is no community bond: you’re not hurting the ability of a local bank to make loans to your community (or driving up the borrowing costs of your neighbors).

In today’s NY Times Magazine, Roger Lowenstein makes a similar argument:

There are two reasons why so-called strategic defaults have been considered antisocial and perhaps amoral. One is that foreclosures depress the neighborhood and drive down prices. But in a market society, since when are people responsible for the economic effects of their actions? Every oil speculator helps to drive up gasoline prices. Every hedge fund that speculated against a bank by purchasing credit-default swaps on its bonds signaled skepticism about the bank’s creditworthiness and helped to make it more costly for the bank to borrow, and thus to issue loans. We are all economic pinballs, insensibly colliding for better or worse.

The other reason is that default (supposedly) debases the character of the borrower. Once, perhaps, when bankers held onto mortgages for 30 years, they occupied a moral high ground. These days, lenders typically unload mortgages within days (or minutes). And not just in mortgage finance, but in virtually every realm of our transaction-obsessed society, the message is that enduring relationships count for less than the value put on assets for sale.

And, like the Mad Biologist, Lowenstein also believes in caveat mutuor (italics mine):

No one says defaulting on a contract is pretty or that, in a perfectly functioning society, defaults would be the rule. But to put the onus for restraint on ordinary homeowners seems rather strange. If the Mortgage Bankers Association is against defaults, its members, presumably the experts in such matters, might take better care not to lend people more than their homes are worth.

Comments

  1. #1 Lyle
    January 10, 2010

    The morality arguement is a left over from the Puritian days when defaulting on debt was a sign you were not one of the predestined elect. Back then we just threw the defaulter in Jail and waited until he paid. The fact that business has one set of rules and individuals are supposed to have a more stringent set of rules has become apparent to people and they are deciding that the old rules don’t apply. Now expect soon that non recourse states will change to recourse states, so that after forclosure you will be sued by the bank for the difference, and have to declare bankruptcy to get out of it.
    One should also note that if you used the house as an ATM i.e. refinanced for more than the purchase price, you will still have to pay income tax on any money you are forgiven above the purchase price i.e. take the mortgage price, subtract the purchase price and any positive amount remaining will be taxed the exemption is only for purchase money.

  2. #2 Russell
    January 10, 2010

    Be careful. In many states, simply defaulting on a mortgage doesn’t free you from any excess debt, after the mortgage-holder forecloses and sells the house. That debt can turn into a judgment which then gets you hounded by collectors. How you walk away from a mortgage matters. Various deals can be made as part of walking away.

  3. #3 BaldApe
    January 10, 2010

    Russell,

    That’s what I was going to say. Do you have a list of those states, BTW?

    Just asking ;-)

  4. #4 DaleP
    January 10, 2010

    You wrote:
    Second, since housing loans are traded as commodities, there is no community bond…

    This is generally true, especially for loans generated through mortgage brokers, but not always. For instance, my mortgage is from my credit union, who keeps their mortgages. (They and I were conservative, so I’m still above water.) My brother’s is with a local community bank, which also keeps its mortgages. You’ll probably know if you have a local mortgage, but check if you aren’t sure.

  5. #5 Russell
    January 10, 2010

    Don’t know which states. And, most importantly, I Am Not A Lawyer. I’m just raising a caution to anyone thinking about this that they might want advice from someone who knows more than me — and likely more than Mike — about the legal technicalities of such things.

    That’s no criticism of Mike’s moral argument. It is purely pragmatic suggestion.

  6. #6 Moopheus
    January 10, 2010

    I agree that there isn’t necessarily a moral or ethical question. A mortgage is a business contract, plain and simple. It spells out what happens if you pay, and what happens if you do not. As Russell points, out, various laws apply. There may be practical consequences–it’s a big bad mark on your credit. Going through a foreclosure is a nontrivial event. But the guy on the other side of the trade may be your local bank, it may be Wells Fargo, Citibank, MERS, an investment REIT. Whoever. But almost certainly a party that is not going to make any moral consideration on your behalf, so why should you feel any on theirs?

  7. #7 Lyle
    January 10, 2010

    Just type recourse mortgage into your favorite search engine and you should get the answer to the question.

  8. #8 Tony P
    January 10, 2010

    Here’s a fun exercise. Before the foreclosure process starts and you sense you’re going underwater on the mortgage, just craft a little letter saying you want proof of the debt with your signatures, etc.

    Also say that if they cannot PROVE that you signed it (And it’s extremely likely that they cannot!) then the mortgage doesn’t exist.

  9. #9 Katherine
    January 10, 2010

    @ Tony P:

    Wow, really? Where did you get the information that they will be unlikely to be able to prove it? Is it common for banks to not keep paperwork these days?

  10. #10 llewelly
    January 11, 2010

    Every oil speculator helps to drive up gasoline prices.

    This is not at all a fair comparison, because a strategic default comes with significant long-term costs that speculation does not. Further, a strategic default does not cause the lender to lose any more money than they would have if they had simply bought the house and held on to it until the day you walked away, rather than you buying the house.

    If the comparison to speculation was fair, it would not be an argument in favor of the morality of a strategic default; it would be an argument against it. (In my view, speculation is theft, as it increases costs without providing value.)

  11. #11 llewelly
    January 11, 2010

    Wow, really? Where did you get the information that they will be unlikely to be able to prove it? Is it common for banks to not keep paperwork these days?

    There have been several court cases in which people ended up owning a home free and clear, precisely because they did as Tony P suggests, and in fact the required paperwork was never produced. Nobody really knows how common it is for the paperwork to be unfindable, but it’s important to keep in mind that for many mortgages, the mortgage has been bought and sold and repackaged several times – thus, it is not a matter of just one bank keeping the paperwork. Every institution which handled the loan must produce paperwork. Obviously it is much more likely that one institution of many will fail, rather than it would be if a single institution had handled the loan. More importantly, a large portion of the loan trading institutions have vanished, and thus cannot produce any paperwork, even if they originally kept it. The law of large numbers clearly favors those who follow Tony P.’s advice, but how high it raises their chances is hard to say. And in the current economy, you may have nothing better to do with your time and energy.

  12. #12 James Hanley
    January 11, 2010

    If the Mortgage Bankers Association is against defaults, its members, presumably the experts in such matters, might take better care not to lend people more than their homes are worth.

    Just a nitpick, but it’s exceedingly rare for a person to be loaned more than their home is worth at the time of the loan. That the house’s value dropped later does not mean it wasn’t worth that much at the time.

    Every oil speculator helps to drive up gasoline prices.

    And this statement is flatly false. If you are a speculator who thinks the futures market is overpriced and you sell short, you are actually helping to bring the price back down. Speculators don’t work at all like most people think–it’s not just a game of bidding prices up and up and up.

    As to the general point of the post, however, I mostly agree. There are exceptions–if a person had planned to stay in their house for decades, it may make sense to stay there despite being underwater, unless you can walk away and pick up something less expensive in which you will be happy for decades, actually reducing your debt load. But if you plan to stay in a place for decades, the market will eventually catch up again. But since many–perhaps most–people were only planning 5-10 years in the house, treating it like a bad business deal and getting out of it is the best option.

  13. #13 Nelson Chamberlain
    January 11, 2010

    Here’s a link to an article in the NY Times about what can happen if the bank/lender can’t produce the proper paperwork:
    http://www.nytimes.com/2009/10/25/business/economy/25gret.html?_r=1&partner=rss&emc=rss

    The basis for the judge refusing to allow the bank/lender to foreclose on the house is that they could not prove they had a legal interest in the property. The paperwork/title to the property had not been properly registered when the mortgage was bundled with hundreds and thousands of other mortgages. In effect the judge wiped out the debt because the bank/lender couldn’t prove that the debt legally existed. Importantly, however, it does not give title to the property to the people living there, so they would never be able to sell it until title is resolved.

    I find it interesting that mortgage comes from the Old French, meaning “dead pledge”. It’s a little scary to think of how they came up with that term. . .

  14. #14 Troublesome Frog
    January 11, 2010

    Just a nitpick, but it’s exceedingly rare for a person to be loaned more than their home is worth at the time of the loan. That the house’s value dropped later does not mean it wasn’t worth that much at the time.

    I think that when you’re loaning out money over a period of 30 years, it’s worth expanding your definition of “worth” for the collateral to something a little more in line with reality than its current market price. The assumption that the current market price was equal to the long-run value of the house is what got us into this mess.

  15. #15 Billy M
    March 12, 2011

    I have a rental property that is approximately 20K underwater. I am having to borrow on a equity line to make the note each month due to lack of tenants. I am at the point of default which led me to this article. My main concern will then be will they have right to go after my primary residence although it is with a differnent lender and also in my wife’s name, not mine…which may help. Thanks

  16. #16 Sid
    March 27, 2011

    My wife and I are strategically defaulting on our home as we are underwater, loss of over 250k. We have no moral qualms as the banks and private corps engage in strategic default without such qualms. As already said, the banks and corporations have no moral qualms on our behalf, why should we on theirs? It’s just business.

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