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Your Take: Default on Underwater Mortgages?

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Foreclosure!There’s an interesting article on the Consumerist two days ago discussing a paper written by law professor Brent T. White of the University of Arizona. The paper, “Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis,” argues that more people should be strategically defaulting on their mortgages but don’t because they feel guilty and because the consequences of foreclosure are overblown.

If a business finds itself in a bad loan, it can go bankrupt and restructure (Trump has done it about a billion times!), but people can’t because people have feelings and a conscience. Obviously bankers hate this paper because they would prefer it anyone, individual or business, continues to pay on a loan regardless of the financial implications.

What do you think? Do you think it’s OK to default if it’s the financially correct choice?

Personally, I’m a little mixed. I think businesses should be held to the same standards as individuals, not the other way around, but that’s simply not possible. So that leads us to our current scenario, which is whether it’s OK for someone to strategically default and I think that’s OK. If we think it’s OK for the Trump empire to restructure its debts, why not let individuals?

I’m really curious to hear what you guys think about strategic defaults.

(Photo: respres)

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60 Responses to “Your Take: Default on Underwater Mortgages?”

  1. I think to take advantage of the system is the American way no? Walking away from your underwater mortgage makes you money in the short term.

    Hopefully in the long term, we learn, but if the government can bail you out and saving you hundreds of thousands, why not?

    Why have to STOP fighting the government, and start asking for hand outs.

    GO USA!

  2. Ron says:

    I really think it’s the “To big to fail” reasoning. A Homeowner in default affects the economy very little (unless there are millions of foreclosures all at once, as we’ve seen). Businesses affect other businesses and many employees. This is the capitalist society we live in and unfortunately it does not seem fair but for the greater good, I guess it is.

  3. tim says:

    the consequences should be greater for defaulting on a mortgage, so people don’t walk away from them. the underlying principle of equality is that when we commit to something we do it. if you cannot, then there out to be repercussions. the problem with all this walking away is that it dilutes the concept of what it means to have a contract. i think this should apply to businesses too.

    i do think our bankruptcy code for businesses ought to be different than personal debt, because businesses employ people and we also want to spark innovation and small businesses and not prevent people from going into business. however, if a person shows a tendency to continue fail, or they are purposely failing businesses for tax reasons, then there should be repercussions…maybe a 3 strikes your out rule.

    • NateUVM says:

      The rest of this discussion aside, I’m not really sure that walking away in tantamount to a breach of contract. Per this “contract” that you have with the lender, you can walk away. There ARE consequences, per the “contract.” You lose your collateral.

      I think the point of the discussion here is that many people don’t truly understand their options and the REAL ramifications of those options under this “contract.”

  4. Chris says:

    I don’t believe that this is a moral issue. Your mortgage lender does not feel any moral obligation to keep you in your house. Felix Salmon has had some very interesting things to say on this issue. He says that our system is:

    “Tilted enormously in favor of institutional lenders who exist in a world of morality-free contracts, and who conspire to lay the world’s largest-ever guilt trip on any borrower who might think about joining them in that world. It’s asymmetrical, it’s unfair, and it’s about time that homeowners started being informed that a ding to their credit score is not the end of the world; that no one would expect a capitalist company to behave in the way that individuals are being told to behave; and that their options are in fact broader than they might believe.”

    Here’s the link to the article: http://blogs.reuters.com/felix-salmon/2009/11/30/the-worlds-largest-guilt-trip/

  5. Seth @ Boy Meets Food says:

    As much as I hate to say it, I guess it is ok for individuals to walk away from underwater mortgages. I think it has to be a personal ethical decision though. Personally, I don’t think I would, but I can understand why others would make that decision.

    It is the lender who gets hurt by the borrower defaulting, and if you think more about it, the lender entered that business agreement with full knowledge that the borrower’s default was a possibility. The lender is taking a risk in loaning the money for the purchase. If the price of the house drops significantly and the borrower bails, then I guess their risk didn’t work out for them. Maybe it will teach the lenders to be more thorough in their research on who they are lending to, but more particularly researching what the money is to be lent for.

    • aua868s says:

      Would defaulting on underwater mortgages in any way impact the borrower’s credibility (credit score, etc..) which would make it hard for future borrowing?

      • Jim says:

        Yes it would, defaults are very bad for your credit because you’ve effectively failed to meet your financial obligations, likely your largest one.

  6. Diasdiem says:

    This isn’t just about people who thought they could afford a fancy house on less than $30,000 a year. It’s not just house-flippers. People who got their mortgage several years ago with the intention of living in the house, and if they moved, selling it for enough to break even or even make a little money (which wouldn’t be a lot, after inflation and taking into account the expenses of home ownership) suddenly find themselves owing more than the house is worth. The reason is because the housing market is saturated with foreclosed homes up for sale because of the subprime fiasco. Which the banks are greatly responsible for. These people got put into this situation by the same banks they owe money to.

  7. I think you raise a very interesting question. I sat in on a lecture by a banking executive about 18 months ago. As he described the housing market and sub-prime lending, he stated that Americans with an under water loan suddenly become businesses and make a business decision to foreclose. I agree that it doesn’t seem right that individuals are held to a higher standard than businesses. If anything it should be the other way around. I think Americans should do everything they can to payback the debt that they signed for. But there is a point when it simply makes sense to foreclose.

    • saladdin says:

      A business will not just shut its doors at the first hint of trouble. A business cuts expenses, restructures, borrows etc.. They fight and claw.

      People who default based solely on being “underwater” are not making a business choice. They are making a personal choice.

      But, default is a part of the contract between the bank and lender. Pay or lose the house. The bank gets the property back and the people lose thousands over their life due to bad credit.

      saladdin

  8. CK says:

    If you think it’s the best move for you then walk. You and your lender have a legal contract not a moral code.

  9. There are two parts to this.

    I completely disagree with people walking away if the primary reason for the default is that the house is worth less than the mortgage balance. If you can pay the loan, you should stick it out. Walking away in this case is saying that the house was never more than an investment and since the investment isn’t panning out it’s time to get out.

    Flip side–people who can’t pay, and can’t sell for enough money to pay off the loan. A short sale is preferred, but if the bank plays hardball, there may be no other choice. In some markets it’s close to impossible to sell a house at any price, let alone for enough to satisfy the mortgage. In these cases I think it’s OK to walk. You’ll be foreclosed on either way so…start walking.

    • saladdin says:

      I find it amusing that people think others should “stick it out” when it doesn’t happen in any other aspects of life.

      People divorce, leave jobs because they are unhappy, drop out of school, disown kids, let cars get repo,drop pets off at others houses in the dead of night….

      We are a nation of quitters. Any discussion of morals and ethics is laughable.

      saladdin

      • CK says:

        I don’t know about a nation of quitters. Nothing wrong with being rational and pragmatic.

        • saladdin says:

          And that argument can be used for everything from divorce to abortion. That’s all I’m saying. This debate about defaulting is not a new topic or only recently created. We have been doing this forever in all human actions.

          saladdin

      • “People divorce, leave jobs because they are unhappy, drop out of school, disown kids, let cars get repo,drop pets off at others houses in the dead of night….”

        Yes, and you see where that’s getting us…

        It doesn’t matter what others are doing. The relevant question to each of us is, What kind of person do I want to be?

        • saladdin says:

          The problem with “what kind of person we want to be” is that it is in or DNA to be selfish asses. Yes we do “good” things but humans ALWAYS regress to the mean. And that mean is being a selfish ass.

          I’m not advocating one side or another here. I’m just saying that everyone is overlooking the simplicity of being human. I just don’t get why anyone would be surprised or upset that people do this.

          I love the psychology of this.

          saladdin

          • Jim says:

            In the end, you have to take care of yourself and your family. You have to do what’s smart for you. It’s easy for people who aren’t underwater or aren’t in a bad situation to say “just grin and bear it, you can make it through.”

          • saladdin says:

            What about the greater good?

            To me that’s the sticking point here. You say take care of your family is #1 but then on the other side of our mouth people complain when their neighbor does it.

            It’s ok when I do it because I’m #1 but when everyone in my neighborhood does it and kills my property values then they are all dead beats.

            saladdin

          • Jim says:

            I agree, you can’t have it both ways. It was a lot like that when people would complain about some parts of the stimulus because it didn’t apply to them and then demand to know where their stimulus checks were.

          • CK says:

            We need to get past the notion that doing things for yourself is a bad thing. When you rob a liquor store for money for yourself that indeed is a bad thing. But when you take an option available to you in a contract you’ve made (in this instance, walking away) well that’s the way the cookie crumbles.

  10. Maddhatter says:

    Personally, I bought my home for a place to raise a family, and the ability to call a place my own. The market going down does not change that reason. Of course, I bought on a fixed rate for 30 years and it was something I could easily afford on my salary, which I think is the real problem behind all of these “examples”.

  11. I believe it’s right to act with integrity and do the right thing – all the time.

    Look at a mortgage. The banks don’t do the right thing. Too often, it’s easier for them to foreclose and then sell the house at a huge loss. The right thing to do is to save some money by offering the about-to-default borrower a break. It’s a win-win. But, no dice. They look out for themselves.

    It is entirely appropriate to walk away from an underwater mortgage. What is not okay is damaging the home or making it any more difficult for the mortgage owner.

  12. zapeta says:

    It really would depend on your situation. If you are underwater but can make the payments and defaulting would mean you have to uproot your family then it doesn’t seem like a good idea. I don’t see any real ethical dilemma though…the banks are more than happy to change the terms of contracts to fit their economic needs so why shouldn’t someone do the same to them if they want?

    • Jim says:

      The problem is making payments on an underwater house doesn’t make financial sense, it’s like paying $5000 for something worth only $3000… you might as well default and buy it again at $3000 a little while later.

      • saladdin says:

        But can we do this with cars? The percentage of people underwater on cars has to be way higher then houses.

        For some reason when people apply this idea of defaulting to a house people seem to think it is ok.

        saladdin

        • Lord says:

          Actually, it is rare for people to be underwater on cars because lenders know they depreciate and even use altered amortization to avoid this. It only becomes an issue when gas becomes expensive or the economy declines changing the market for specific vehicles. The other case is if the owner has run it down, put on too many miles, or damaged it, one reason the lender is on insurance policies for them. The reason people don’t walk away from them is their is more to lose than gain. If lenders had exercised the same caution in housing, we would not be in this situation.

          • saladdin says:

            I really think you are off if you believe most people are not underwater on cars.

            Buy a new car and drive it off the lot then put a for sale sign on it the same day. These things automatically depreciate on day one. Throw in the fact that most do not put a down payment and you are talking upside down vehicle on day 1 of purchase.

            I’ve never heard of anyone flipping cars like they do houses. Have you?

            saladdin

          • Lord says:

            Don’t confuse depreciation with being underwater. A seller can require a down payment that prevents being underwater or they can up the price to cover any losses from being underwater. The fact that a buyer will pay more than a seller for the same merchandise is not the same as being underwater but a recognition one is taking a price and another setting it. Sellers will of course accept the vehicle back and resell it making them flippers and do so profitably, but buyers can’t compete because they do not have access to the same costs and volume. They are free to become dealers if they think they can compete.

          • Lord, I don’t think it’s entirely true that it’s rare for cars to be underwater. I friend of mine sold cars at a popular dealership and said people buying cars underwater is typical, they just don’t know it.

            He said they take deficiencies from their current vehicles and roll it onto the next loan. They call the term “upside down”.

  13. freeby50 says:

    If you can’t pay a mortgage and are insolvent then walking away can make sense. Defaulting on a loan that you can’t pay is not amoral in my opinion.

    The bank and the homeowner are bound by a legal contract. If either party breaks that contract then there are consequences. If you default on the loan then the bank gets to keep the house, they might have the right to come after you for the difference and it will screw your credit.

    If you’re insolvent then you should walk away. Theres no reason to be buried in debt just to keep a bank happy. Walk away.

    If you are not insolvent then it depends on the situation. If the home is not significantly underwater then walking away doesn’t make sense to me. If the home is substantially underwater then I’d negotiate with the bank.

  14. Lord says:

    The reason people are reluctant to do so is the golden rule, they would not want someone to default on them, but how likely would it be for them to be in that situation in the first place? Walking away wasn’t too costly in 2007-2008 when taxes on the phantom gains were waved, but it can be costly now if you aren’t prepared to declare bankruptcy. I would prefer if people viewed it more as an economic decision and as long they properly evaluate the costs and benefits decide appropriately. It is not to anyones benefit other than a lender that did not do their job in the first place to keep people indebted beyond the point of reason. The rest of us would be better off if they had that money to spend other things.

  15. eric says:

    Very interesting topic you brought up Jim. I was mostly on the fence about this but I do think it’s ok now. I’ve known people in my life who have done this and although I don’t think it’s “right,” I can’t argue against their logic of throwing money into something that isn’t worth it.

  16. LL says:

    My opinion: Part of the problem is that there’s no standard consistently applied to home values. There’s only recent, comparable sales. It’s true that something is only ‘worth’ what someone else will pay for it – that is, when the thing is for sale. If you’re not selling, or don’t need to sell, then that’s not applicable.

    I think if you can, and want to, live in your house, pay for your house, it doesn’t matter THAT MUCH what similar houses are selling for at this moment. Your home’s ‘value’ isn’t actual money in your pocket, it’s imaginary, a piece of paper. Like the stock market. There’s no money in a vault somewhere you can go get. There’s only buyers, sellers, and holders. What you bought (holding) is ‘worth’ what someone else recently paid, IF YOU ARE SELLING.

    It doesn’t seem like it would be so easy to walk away from an existing house and just go buy a similar one, cheaper. Wouldn’t there be a lot of expense to that? Renting is also expensive – with no possibility of a free and clear house in the future. I’ve heard (locally) that the only people getting houses at a rock bottom price are cash investors. Regular buyers can’t get loans, can’t get responses to their offers, spend months looking and waiting.

    My point is that the comparison and decision is not as simple as your current mortgage held up against recent comps. There’s more than one single, simple financial consideration about what house to live in. But, I don’t think any of those considerations are moral. All things considered, if it is the ‘right’ decision for a household to walk from their mortgage, then it’s not immoral. It just seems that a lot of people’s perspective on that decision is skewed right now.

    I should add that I’m a renter with zero connection to the housing or banking industries, and I would someday like to buy a house that is not a grossly inflated price, as I believe many still are.

    Renting is a major pain in the tush, but we all have to live somewhere.

  17. @Saladin & Kevin@Outofyourrut are on the right track. “A business will not just shut its doors at the first hint of trouble. A business cuts expenses, restructures, borrows etc.. They fight and claw.”

    It seems we are confusing a couple different scenarios. When a business is insolvent and has no hope it can file for bankruptcy. If the courts agree debts can be discharged.

    The same goes for a person. If you can’t meet your obligations the law provides an opportunity for a fresh start.

    When somebody can afford to meet their contractual obligation they should, period.

    @Jim Everyday people overpay for cars, boats, clothes and even food. If they choose, they can sell at a loss, eat the difference and try to make better deals later. The same should hold true here.

    Personally I believe if somebody that is not insolvent walks away, they should be sued for the full bill and this should not be allowed to be discharged in a bankruptcy.

    Lack of personal responsibility is a big part of what got us in the mess to begin with. Let’s not make things worse.

  18. Stonewall says:

    Here’s my take

    1) take care of your family first, there’s enough stress in this economy don’t add to it.
    2) Residential rentals are cheaper than buying and will be for 2-3 more years.
    3) Your FICO score already sucks if you haven’t made a payment for over 3 months. And will be that way for 7 more years.
    4) Negotiate with the bank to cram down the mortgage. Bank maybe willing to take a 20% haircut, when they consider the 30% foreclosure alternative. Be forceful and prepared for a long process.
    5) Don’t use deferred retirement money to save the house. Stupid, Stupid, Stupid. That’s the only thing going up, up, up right now.
    6) Research the tax consequences prior as every state is different, but right now more than likely the 1099-C that you’ll get for cancellation of debt income will be a non taxable event.

    Adios!

  19. qixx says:

    I feel that anyone underwater should walk away; be it a car, house, or anything else. By holding onto a home that is underwater you are artificially increasing home values. When you walk away there will be an immediate drop in surrounding home values. By holding onto the home you are reaffirming that you feel the home is worth the total price you will pay.

    It that does not convince you remember that when you walk away and the whole block drops in value … that is good for me when i go to buy a home. Sure it may be selfish but i got to look out for number one.

  20. fishboyridesagain says:

    There needs to be someone standing up for the individual consumer. Businesses get away with so much, and most of that under the guise that corporations are given the rights of individuals. A few individuals should just walk away. Maybe this would highlight poor behaviour from corporations, and maybe it will serve as a better reminder to stay away from the lies that created this credit abyss in the first place. Someone needs a bite in the behind, and it’s not just the individual consumer.

  21. saladdin says:

    I remember all the forums who had rent vs buy debates, just like this one.

    I hope we can finally put to an end the myth that homeowners care more about their community, make smarter financial decisions, take more pride in their home and make a more stable neighborhood versus renters.

    saladdin

    • Jim says:

      I think every one of the myths you listed is a myth except for the last one in terms of stability, I think if a lot of people own in the area it’s more stable simply because the barriers to entry and exit are much higher on home purchases than home rents. That being said, how do you define stable? If it’s simply a matter of turnover, yes it’s more stable. Is it safer? Quieter? You can’t make those types of assumptions.

  22. daenyll says:

    If you buy anything, say a tv, and a month later the same model goes on sale. Yes, you might kick yourself for not waiting, but you felt at the time of purchase that it was worth the price you decided to pay. I think if you felt the house was worth the price at the time you bought it you are responsible for fulfilling the payments you agreed to at the time of purchase until such time when that becomes a problem and then you should turn to bankruptcy.

  23. Tim says:

    the problem i have with the notion of walking away from underwater mortgage is there are plenty of people who bought the house to begin with under the assumption they could afford it and they want to live in it. what has changed? they no longer want to live in it because the mortgage is underwater? i think you have to define the scenarios, because it seems there are too many people that want to walk away from an underwater mortgage for the simple fact it is currently underwater. most of this is stemming from we have no sense of responsibility because we think the mortgage lenders and govt have no sense of responsibility either. fine. but there needs to be stiff consequences for doing so, which there aren’t. now there are cases where people have to sell (and i’m not talking because they lost a job, or they bought more house than they could afford to begin with), and in those particular cases there should be some assistance (we do for the military folks) to help cover that won’t ding their credit.

    we have to insist our neighbors be responsible, and letting people walk away scot free with a minor ding doesn’t do it.

    • Ru says:

      I’m getting tired of hearing variations of the phrase “just because the mortgage is underwater”. I’m not considering walking because my mortgage is underwater today. I’m considering walking because I see no signs that my mortgage will stop being underwater in the next 5 or even 10 years.

      Despite buying my home with 20% down (and buying a home I can easily afford) I am now 15% underwater. That means I’ve lost both my cash down payment and all equity. Payments I make now are toward making up the difference between the current value of the house and what is owned. It will be years before the market recovers enough to raise my home value to the value of my mortgage, and I’m young enough that the mortgage is relatively new (3 years old) and therefore mostly payments on interest. I am throwing money down a hole that I will not see for a decade or more, if ever. And that assumes that the market DOES recover that 15%.

      The government has put together several programs to help people underwater or unable to make payments keep their houses, and the banks, seeing a loss of profit, have failed to implement them. Last count not even 500k modifications had been done under the plan implemented last january, because as any bank official will tell you they LOSE more money in fees and interests by doing the modifications than the government will give them. To me it seems that the other side of this contract is set on taking whatever they can get from me, so why should I be concerned with them.

      I am amused by the tendency to blame your neighbor who walks rather than the banks and financial industry who put them into a position where it makes the most sense to do so.

  24. Tim says:

    @Saladdin you are correct you don’t have to stick it out, but there are consequences for every action if you want to get out, whether it be alimony, guilt, whatever. i’m disturbed that we seem to be moving towards a no consequence society.

    you take a risk buying a house just as you do purchasing anything or investing in anything. the common assumption, and poorly so, the last decade or two has been that housing had nowhere to go but up and we were treating it as an investment. We suddenly forgot that investments have risks associated with them and past performance isn’t a guarantee for future success. Flipping houses was all the rage over the past decade plus, and i tell you, just like losing your shirt on shorting/loging or margin calling stocks, you need to pay the piper if you made a bad call. there were plenty of people who made bad calls on houses.

  25. Bill says:

    A mortgage is a contract just like a lease, if you need to break a lease, you pay the penalty specified in the contract and move on, no one thanks that is a moral?h


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