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!