Walk away from your mortgage

Meg from World of Wealth recently posted a response to Ginger from Girls Just Wanna Have Funds’s post about unpopular PF opinions. It turned into a somewhat entertaining fight in the comments (go read!), but first I wanted to remark on this unpopular opinion:

Given the present state of the economy, people should be able to walk away from their homes if they are “under water” by a certain amount without penalty.

Meg was pretty pissed about that. The way it’s worded, I can’t agree either. Meg’s problem came from the fact that people wouldn’t be paying what they owe; she asks “why make banks take a loss?”

Why? Because they are a business. They have a contract with the house buyer, and it’s implicit in that contract that if the borrower can’t or won’t meet the conditions of the contract (i.e. they can’t/won’t pay their mortgage), the bank has the right to seize the property. Often, mortgages are non-recourse loans, meaning that the banks can’t go after anything more than the collateral for the contract – i.e. the house – if the borrower defaults. Banks knew this going in. Well-Heeled linked to a fantastic article on Twitter that explains this.

The article states, “If the value of the loan is less than the value of the collateral, the best option for the borrower is to leave the option unexercised, i.e. to walk away without using the option to repay the loan and claim the collateral (you want the house only if it’s worth more than the loan).”

It’s not ethical, maybe, but most people are completely within their rights to walk away.

The article goes on to talk about what might be driving the willingness to go through the shame of foreclosure: the media’s reports about predatory lending, which means people feel justified because they’ve merely been a victim of unscrupulous banks; the widespread foreclosure problem, which makes it less shameful since a lot of other people are doing the same thing; and societal changes that make us less likely to care about what others think of us.

(It’s really a fascinating article; I highly recommend it.)

Meg works in banking, so I can see where she’s coming from. I don’t think banks are big and bad and evil, but I think they neglected to protect themselves. Knowing that this was a possibility, that they could be left with houses instead of money, makes the excessive lending seem even more monumentally stupid. I don’t have sympathy for the banks, because they should have seen it coming. (There is a quote from the CEO of Bank of America, who says, “I’m astonished that people would walk away from their homes.” It makes me laugh every time I read it. The article in which this appeared in the Wall Street Journal goes on to say, “… there is a new class of homeowners in name only. Because these people never put up much of their own money, they don’t act like owners, committed to their property for the long haul.” It’s almost… poetic.)

As I said above, though, whatever the mortgage contract say or don’t say, I have one major problem with the opinion in bold: the idea that this should come without penalty. There should be penalties!

1. Trashing of credit scores.
This will probably be meaningless by the time this whole mess is over since there are so many people facing foreclosure, but if you default on your mortgage, your score should be destroyed. Sorry, that’s what it’s there for.

2. Worse loan terms in the future.
I have no idea what banks are supposed to look at when they are approving you for a loan, but if your credit report indicates foreclosures, they should look closely at all of it! Your loan terms should be stricter if you’ve previously defaulted. That’s just smart business.

3. You should have to pay taxes on what the bank considers to be the remainder of your loan.
There were a lot of articles about this tax law last year. I believe it was waived for 2008 taxes. I don’t think it should be waived again. If the government is going to be propping up the banks, they deserve the taxes. I’m all for offering nice payback terms – no interest or penalties – but the money should be paid.

What are your thoughts?  Let me know in the comments!

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8 Responses

  1. Agreed! Walk away and stick it to the banks that made stupid loans.

    We wouldn’t be in this crisis if banks had stuck to reasonable lending standards: 20% down, full documentation, reasonable DTI.

  2. I haven’t read the posts you reference. I’ll have to go read them, the discussion sounds juicy! I’ve followed a local housing blog for a long time and the audience there mostly sides with the underwater homeowner. They take a similar approach, the contract lays out the terms if one party does not uphold the bargain. They see it as a business transaction only and if it makes business sense to walk away, then you should. I’ve discussed walk aways before, whether there is a moral implication to them. I’m torn, it doesn’t mesh with my personal ethics. My loan is recourse anyway – and I make enough to go after! Would I walk away if I could? Probably not even though it makes financial sense.

  3. I do think it is ridiculous that people talk about “stupid greedy homeowners” without mentioning how stupid and greedy the banks were right along side them. I guess they were packaging them up into fancy financial products and selling them on wall street (rated as super safe), so they didn’t care. By the end, when things were very very wrong, people were defaulting on their very first payment.

    I told Meg I agree, but I also agree with this. I don’t know. I’m just glad I was too young to even have been thinking about home ownership. I can’t imagine the stress of being 100k underwater.

    (first link isn’t formatted quite right)

  4. All actions have consequences. I agree that people who walk away from their mortgages will suffer in the long term due to the trashing of their credit scores. This will affect their job prospects as well as their ability to rent I also agree that “loans” that were forgiven or walked away from needs to be repaid through taxes. Depending on the size of the loan “forgiven”, the taxes should be allowed to be paid in installments, though.

  5. @ W.C. V: I don’t know if I want to stick it to anyone; I just read the articles and felt I had to respond.

    @ Miss M: It dissolved into a full-on bitch fight almost immediately. I enjoy internet drama more than I should! Ethically, I’m with on leaving a house. I don’t think I could do it!

    @ SP: I so so wanted a house in 2005. Some guy at work told me about how I could get a loan. I called my Dad, who told me what the loans were & how it might all be a bubble. I passed, and later found out my work friend had 10 houses and was underwater on all of them.

    @shtinkykat: Yeah, I know it’s the banks fault for writing the loans that way, but people need to take some personal responsibility. So, it’s cool if you need to walk away, but you’re going to pay the price. If people think there are no consequences, why would they try to do better next time?

  6. Being a Canadian, I didn’t really understand this weird rule you Americans have until I was listening to a BBC podcast on it the other day. It sounds INSANE to me. The whole concept of “stick it to the banks” is bizarre… YOU CHOSE TO ENTER INTO A CONTRACT WITH THE BANK. therefore, it is your responsibility. yes it sucks. i can’t imagine being underwater on my house. but you gave your word in a legal deal… how is it possible to just get out of it???!!! its shocking. especially when so many people (not all, of course) bought something they definitely couldn’t afford with zero down. the woman they interviewed on the BBC documentary was a well paid professional, and she COULD STILL afford to make her mortgage payments, but decided to take advantage of this rule because she felt like she was paying more than she had to now that her home was upside down. YOU ARE THE PROBLEM, LADY! i don’t know…. its just bizarre to me. i’m glad we don’t have this rule here. i do suppose it has helped many people get out of bad situations, but it just doesn’t sit right with the way i was raised. you gave your word, you can’t just get out of it and blame it on “the big bad bank”. but maybe thats just me….

    great blog! i’m new here and i really like it.

  7. 10 houses! Insane!!

    I was also “offered” a house to buy in an “up-and-coming” neighborhood….by my BF’s dad, nonetheless. I immediately said I wouldn’t do it….I didn’t make enough to support a house in case of any emergencies or if a renter bailed (I’m talking $300k worth of house. he was nudging me to get it as a rental property.) His sister went for it though. I hate saying “I told you so”, but I couldn’t help but think it when her renters turned out to be a disaster and she ended up selling it at a huge loss. [sigh]

  8. I skipped the point on my last comment, lol….I’m always torn on this debate. Part of me always screams “idiots! Quit complaining, you had to know what you were getting into” (regarding both sides: banks and buyers), and then part of me recognizes that….well, sometimes you can’t help but want to get in on “a good deal”, right? The weak (and often greedy) were played upon by more greed.

    Maybe there’s a loophole in a contract that states you can just walk away, but it just feels wrong, and like some of you I don’t think I could do that either. Then again, I’m also a strong believer that you never know what you’ll do until you’re in that situation. And I don’t mean that as an excuse to weasel out of things I’ve previously promised myself….sometimes you either don’t know what’s going on in someone’s head, or there’s an aspect of an issue you haven’t thought about. (I think it goes hand in hand with “there’s two sides to every story”)

    I know I’m weaving around a point, but I think they’re relevant thoughts. lol. =]

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