Quote of the day

Loading Quotes...


Giving the Bank the Keys

The recent topic I find trending up (my own observation, not from any particular tracking site) is that of walking away from your mortgage, otherwise known as “giving the bank the keys.”

I’ve been reading about moral hazard and the risk of further collapse in home prices should people continue to default, but it was only when I ran into articles such as Motley Fool’s Why Are Homeowners Idiots? did I realize that there are a number of financial writers not just observing this phenomenon, but advocating it.

Empty Nest Syndrome
Creative Commons License photo credit: bitzcelt

In a New York Times article, Walk Away From Your Mortgage! Roger Lowenstein compares a homeowner to a business which routinely chooses which ventures to keep funding and which to let fail. The reason we’re are not seeing more homeowners simply walk away is that defaults are considered antisocial and even amoral. It’s this appeal to morality that has our president urging homeowners to follow the “responsible” course.

Professor Brent White from the University of Arizona is frequently quoted as suggesting that not walking away from a house that’s underwater (i.e. worth less the mortgage) goes against one’s economic self interest and perhaps shame and guilt keep them from doing so. Even our government has made the process easier. Until recently, forgiven debt was considered taxable income. The bank sells your home and comes up $200K short, it’s as if you got that much extra income that year and a hefty tax bill follows. This is no longer the case as debt forgiven on one’s primary home is no longer taxed.

As with many issues, I don’t find this one to be so black and white. I can use some more time to ponder this issue before deciding, it’s not as though I have a default planned. I’m within about 7 years of being done with our mortgage.

Joe

  • Greg February 4, 2010, 8:55 am

    It seems that all this advice to walk away if you are underwater today is blissfully ignorant that tomorrow (or at least several tomorrows from now) that property mostly likely won’t be underwater. God forbid that you can still afford the mortgage for an underwater property, apparently to many of these people you should still ruin your credit for years instead of just letting time catch up.

    I’m sure that there are some areas that the lose of value is so extreme that it may be many, many years until these catch up. Maybe for some of the walking is the right move – right after coming to terms that you purchased an overprices property.

  • Augustine February 4, 2010, 12:07 pm

    Having the comfort of not finding myself in this situation, I’ve pondered a little.

    I think that most owners are returning their homes to the bank not so much because they’re underwater, but because they cannot afford it, be it because they lost their jobs or because they were hit with an ARM reset. In such cases, they have to chose between eating or a roof, which is not that hard a choice to make in favor of food.

    Other than such extreme cases, when one’s justifiable to cut his losses, I think that a minority of the owners who are returning their homes to the bank are doing so because they considered their homes an investment. I bet that they don’t return their cars when they drive out of the dealer’s lot, when it’s already some 20% underwater, but that’s besides the point. Or not so much.

    I mean, being underwater by 20% is a difference small enough that perhaps will be zeroed before the mortgage is through, possibly far before then. However, there are cases in which peak price was paid for a habitation whose value was hyped far beyond its utility. For example, a $1 million loft in an drab part of town, which will not see any improvement due to city revenue shortages. For the sake of argument, assuming that such loft cannot be sold for more than $100 grand, it’s nearly impossible to assess with certainty that it’ll go up 10 fold even over decades, bar massive inflation. Then, even if it was never considered an investment, it’s not possible to justify paying so much for it. Indeed, it’s better to cut one’s losses.

    We are going through a housing bubble burst, when home prices were highly inflated by easy credit, far outpacing inflation, which must be depreciated now. It’s either unwinding the previous excesses or home ownership will be way beyond what our children will be able to afford.

  • Investor Junkie February 4, 2010, 12:10 pm

    The world is upside down, and I’m not talking about mortgages.

    Moral hazard issue aside, walking away from a mortgage is stupid decision for most people. Repeat after me, your primary residence is not an investment. So they are stupid three times:
    – Initially not putting enough down and/or getting an adjustable ARM (of even better interest only rate)
    – Damaging their credit so it will be even harder to get anything on credit (us regular folk are going to have much higher rates as it is, can you guess for some who does this?)
    – Miss out in any gains they may make in the next say 10 years.

    Many of these homeowners should never have been homeowners to begin with. I say good riddance! There’s a reason why rents have not risen in the past 10 years, because everyone was buying a house!

    Now like Greg has stated if a property is so far underwater (ie in CA it can be greater than 50%) and in 10 years you’ll never make that back it may make sense. For most however they are sheep doing the populist “in” thing to do. After all, they didn’t educate themselves on what do to previously. Bailing out of a house causes no lesson to be learned that’s for sure.

  • Augustine February 4, 2010, 2:41 pm

    I should also say that one cannot forget that in some states the lender can come after one’s assets to make the debt whole even after foreclosure. Unlike banks, which lent injudiciously, people are not bailed out and get the back-of-the-hand treatment.

  • RJ Weiss February 4, 2010, 3:00 pm

    I agree that it is morally wrong to just walk away from a mortgage. There is no question that is wrecks your credit for years.

    However, homeowners who are walking away are seeing that a bad credit rating a small price to pay. With the systems we have in place right now, unfortunately, most of them are better off to walk away. It sucks, but it’s true.

  • LeanLifeCoach February 4, 2010, 5:36 pm

    I too have read stories where people are making the strategic decision to walk-away… only they often suck as much from the deal as possible by living in the house without paying for as long as possible. Not only should these people be sued for breach of contract, it should be considered illegal and they should be punished!

    If your neighbor knowing and purposefully defaults their mortgage company suffers, as a result the mortgage company will be compelled to “make up the difference” elsewhere… and that is you and I!

Leave a Comment