Debtor's Dilemma: Pay the Mortgage or Walk Away

[question everything]

DECEMBER 18, 2009

Debtor's Dilemma: Pay the Mortgage or Walk Away
In Down Real-Estate Market, Homeowners Are Deciding to Abandon Their Loan Obligations Even if They Can Afford the Payments

By JAMES R. HAGERTY and NICK TIMIRAOS
WSJ

PHOENIX -- Should I stay or should I go? That is the question more Americans are asking as the housing market continues to drag. In good times, it would have been unthinkable to stop paying the mortgage. But for Derek Figg, a 30-year-old software engineer, it now seems like the best option. Mr. Figg felt trapped in a home he bought two years ago in the Phoenix suburb of Tempe for $340,000. He still owes about $318,000 but figures the home's value has dropped to $230,000 or less. After agonizing over the pros and cons, he decided recently to stop making loan payments, even though he can afford them. Mr. Figg plans to rent an apartment nearby, saving about $700 a month.

A growing number of people in Arizona, California, Florida and Nevada, where home prices have plunged, are considering what is known as a "strategic default," walking away from their mortgages not out of necessity but because they believe it is in their best financial interests. A standard mortgage-loan document reads, "I promise to pay" the amount borrowed plus interest, and some people say that promise should remain good even if it is no longer convenient. George Brenkert, a professor of business ethics at Georgetown University, says borrowers who can pay -- and weren't deceived by the lender about the nature of the loan -- have a moral responsibility to keep paying. It would be disastrous for the economy if Americans concluded they were free to walk away from such commitments, he says.

Walking away isn't risk-free. A foreclosure stays on a consumer's credit record for seven years and can send a credit score (based on a scale of 300 to 850) plunging by as much as 160 points, according to Fair Isaac Corp., which provides tools for analyzing credit records. A lower credit score means auto and other loans are likely to come with much higher interest rates, and credit card issuers may charge more interest or refuse to issue a card. In addition, many states give lenders varying degrees of scope to seize bank deposits, cars or other assets of people who default on mortgages.

(snip)

Josh Cotner, who owns an insurance agency, says his mortgage balance is about $100,000 more than the market value of his home in Gilbert, Ariz. Mr. Cotner could rent a bigger home nearby for $600 a month, far below the $1,655 he now pays on his mortgage, home insurance and property tax. He says he recently stopped making mortgage payments because his lender wouldn't help him reduce the principal on his loan under a federal program in which he believes he is qualified to participate. Given the sometimes lengthy legal process of foreclosure, he may be able to stay in the home for at least another nine months without making any payments. Banks warn they may get tough with strategic defaulters by pursuing legal claims on a borrower's other assets. "We will try to reduce people's payments if they have a hardship," says Thomas Kelly, a spokesman for J.P. Morgan Chase & Co. "But we have a financial responsibility to get people to pay what they owe if they can afford it."

(snip)

Another risk for defaulters is that banks could sell the rights to pursue claims to collection agencies or other firms, which could then dun the borrowers for up to 20 years after a foreclosure. Such threats appear to deter some borrowers. A recent study from the Federal Reserve Bank of Richmond found that under-water borrowers were 20% more likely to default in a state where mortgage lenders can't pursue claims on other assets than in those where they can.

(snip)

http://online.wsj.com/article/SB126100260600594531.html (subscription)

Printed in The Wall Street Journal, page A8

[notadmblnd]

1. That's what the banksters decided to do

I read a story earlier today that JP Morgan Chase walked away from office towers in San Francisco. Why is it ok for them and not for others?

[DJ13]

2. Compare this to Morgan Stanley

Morgan Stanley, the securities firm that spent more than $8 billion on commercial property in 2007, plans to relinquish five San Francisco office buildings to its lender two years after purchasing them from Blackstone Group LP near the top of the market.

"This isn’t a default or foreclosure situation,” Barnes said. “We are going to give them the properties to get out of the loan obligation.”


Sounds like TPTB want to hold the average person to a higher standard than they operate under every day, doesnt it?

[napi21]

3. I don't understand the 20 year persuit thing. I thought it was Fed. law that a debt can't be

oersued after 7 years as long as the borrower hasn't had any activity on that loan. Of course some agency can try, but you can tell then to stop calling and they are bound to do so.

I can certainly understand if your home dropped $100,000 and you know you'll never recover that. It was the stupidity of some to think they could never lose money on real estate! I have to believe they knew they were paying too much when they bought it!

[exboyfil]

4. This academic talks to us about what is moral?

Walking away from bad business deals is common for Wall Street. Trump declares bankruptcy twice, and he is not living in a tent. If you are willing to live with the consequences, do like the guy in the story - continue to live in the place and do not make payments. You can get up to a year rent free while foreclosure proceedings are implemented. Just don't whine later if you get sued and lose.

Only poor and middle class individuals have the obligation to live up to a contract. If you are rich then you get lots more choices.

[girl gone mad]

8. It's called the "stealth stimulus plan".

Banks are putting off foreclosures so they don't have to take the writedowns, so many borrowers get to live rent-free for up to a year (or more). I've seen estimates that this activity is freeing up as much as $160 Billion a year to be spent in the economy.

[dkf]

5. Why does anybody have to pay any loan?

The question is what are the consequences.

[question everything]

16. And then, why go crying to Congress and to the President that "the banks

don't make loans?"

Why should the banks make a loan if lenders can just say "oops" and walk away?

[roamer65]

24. Delete.

[Merlot]

6. "... have a moral responsibility to keep paying"

Why does that strike me as funny?

[question everything]

7. Well, this is the way it used to be and, I hope is with most of us

You sign a document promising to pay and you pay. You do not sign a document promising to pay only when the value of the house continues to increase. No one held a gun to the borrower forcing him to complete the transaction.

[girl gone mad]

9. Save your moralizing for Morgan Stanley.

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=114x73670

[question everything]

14. I don't care what others are doing

If you sign a paper it is your responsibility to honor it. And, yes, if you walk away it affects all the houses in the neighborhood including mine!

No one held a gun to the buyer's head and forced him to sign document. Perhaps we need to throw people like that in jail. Why do people think that their comfort should surpass others? Why not walk int a store and just walk out with a merchandise since it is "too expensive?"

[girl gone mad]

18. Yes, by all means..

Let's build debtors' prisons. I'm sure that will solve the problem of people being unable or unwilling to pay their mortgages. Let all of these failed borrowers live on the taxpayers' dime for a few years rather than leading productive lives. God knows, that's exactly what this country needs right now. (sarcasm over)

What you are alluding to here is the "morality" of contractual obligation. You are stating that borrowers who walk away are engaging in immoral behavior, equivalent to stealing.

In reality, exiting the mortgage contract is is often a perfectly rational economic decision, if one is willing to accept the full credit and tax penalties involved.

We no longer live in a time where loans are made by your neighborhood banker or a savings and loan, someone you know and trust and feel a sense of social responsibility to. Mortgages are now securitized by large Wall Street banks. Home borrowing has become a virtually anonymous, impersonal transaction between a consumer and a giant corporation.

Many of the loans that have gone bad are non-recourse, meaning the bank can only go after the house and has no claim on any other assets or accounts. The banks can foreclose, but they cannot sue or take any other legal action. They are not entitled to proceeds above what they make off of the foreclosure. The banks were well aware of the laws that were in place when they were writing these loans. Every lender knew that the contract they were party to allowed the borrower to turn in the keys and walk away from the loan, free and clear (albeit, with possible tax and credit score implications). Even in the case of recourse loans, the banks were very much aware of the legal difficulties involved in recovering money in the event of a default. No one held a gun to their heads and forced them to sign the documents.

If these big banks can make short-term 'business decisions' to ignore historic risk analysis and make zero-down, non-recourse loans to unqualified buyers (often engaging in outright fraud in the process), and then later lay off tens of thousands of people at at the first sign of economic peril caused by their own stupid greed and short-sightedness, without any regret or retribution, why shouldn't consumers be afforded the same privilege?

When businesses laid off 1.5 million workers in 2007, it was just a 'business decision'. When Wall Street banks wrote down hundreds of billions in losses, it was purely a 'business decision.' When Morgan Stanley walked away from 5 multi-billion dollar office towers this week, it was purely a 'business decision'. Well, guess what? People are every bit as entitled to make 'business decisions' as corporations are.

Somehow I doubt that you were complaining about "immoral" consumer behavior while it was driving the housing bubble and artificially inflating the value of your home. Until you get the contract laws changed to your liking and enough debtor's prisons built to hold all of these "bad" borrowers, you'll just have to accept that your house has lost value and your neighbors are going to make financial decisions that are in their best interests, not yours.

[pa28]

19. Foreclosures and jingle mail are painful for neighboring homeowners.

Most of us know the sting of paper losses when we see the value of our houses ratcheting down in value by double digits.

Unfortunately many of the "homeowners" in trouble (at least around here) are underwater by six figures or more. They are climbing a steep gradient and will most likely fail in the end anyway even if they can maintain their payments current.

My paper losses are hovering around 40% and I expect them to be around 60% by the time the bleeding finally ends. I'd rather have the bad debts cleansed now and become real assets at a lower price. It's a business decision on the part of defaulters and I don't begrudge them. At least they can be participating in the economy in the aftermath of their mistake rather than become servants to the interest of a debt that was hopelessly inflated to begin with.

[girl gone mad]

20. Well said.

Sorry to hear that you've lost so much equity. I've had my share of financial losses over the years.

The time to worry about irresponsible behavior was back when all of the fraudulent lending was occurring. I agree with you that the sooner prices stabilize, the sooner we can start to recover, and clearing the weak hands out is an important step.

[pa28]

23. The losses are painful but lashing out is a mistake.

I'll never be underwater but I'm certain the losses will grow. When I hear about a short sale or walkaway the imagined price of my property ticks down but I also know the foreclosure house will be arriving in the hands of someone who can actually afford it (long term benefit).

What's tiring is watching people, friends in some cases, facing income loss and a mountain of debt which represents nothing. Most, fearing loss of face will try to live up to a moral code (which the banks are apparently immune from) continuing to pay until they can't anymore. The house, of course, ends up in foreclosure anyway.

[pokercat999]

12. Good luck with that....you live in a quickly changing world and

it's changing for the better......in some small ways.

[question everything]

15. It will be interesting to see what you will be personally affected

by these "changing rules" that you will no longer admire them.

I wonder how many of the respondents here actually own a home. I do and I hope that none of my neighbors will choose this approach.

[pokercat999]

17. I'm not sure of the meaning of your post but for me

personally, I do own (me and Ditech) own a house. Until last summer I owned two, I sold one in June 09. My current house is still "valued" about $100K more than it cost me to build it in 2001, but the market is so depressed and my area is so overbuilt that actually selling it would probably be impossible at anything but a fire-sale price. So in reality if I needed to get out I could probably sell for something just above my cost....but not much. Yes, I still pay the mortgage even though it's about twice what rent would be in this area but that is mostly because we live in a recourse state.

[pnwmom]

10. I guess I don't understand why it's somehow worse to lose money because

you're paying for a loan amount that is higher than your house is now worth -- as opposed to losing money because the equity you had accumulated -- after years of mortgage payments -- evaporates when the market goes down.

Every homeowner is hurt when the market drops significantly, whether they lose equity or are "underwater" in their mortgage.

[phantom power]

13. It depends a lot on the mortgage, and whether your circumstances have changed.

For instance, suppose you are paying $2000/month on a mortage, and you are $200K underwater, and you don't actually have more than a few thousand in equity. You're never going to get that back. It's pretty sensible to consider walking away from that and buying a much cheaper home with a smaller mortgage and being above water.

That kind of scenario will be pretty common for anybody who bought near the top of the market, especially with all the "creative" mortgages that were flying around. Especially if you are one of the millions of people who lost their job in the last couple years.

If you are underwater, but you are not having trouble paying your mortgage, and you like where you live, etc, then it makes sense to stay. My brother-in-law just turned down a promotion that would have required him to move out of state. He's currently underwater. As long as he doesn't move, his situation isn't so bad. Moving would have forced him to eat the loss immediately, which is obviously unattractive. But he's not in a situation where walking away adds up.

[EmeraldCityGrl]

11. This will eventually impact all of us.

Whole neighborhoods will be affected dragging down the cost of the average home as these are sold for pennies on the dollar.
Still, I can't be judgmental since most people are doing what they can to survive. all the rules have changes and new ones are
being made on an as need basis.

[netsurfer2]

21. Seems like stupidity to me

"After agonizing over the pros and cons, he decided recently to stop making loan payments, even though he can afford them. Mr. Figg plans to rent an apartment nearby, saving about $700 a month."

How irresponsible is that!? A lot of us have seen the value of our homes drop. It does not mean you stop paying the mortgage.

[girl gone mad]

22. Walking away is often the most responsible financial decision one can make.

If you have kids to put through college, medical costs, lost a job, need to relocate, or for any of a number of other reasons, ceasing payment might be the best of the bad choices, even if you can still afford the payment.

Many people have lost hundreds of thousands in paper equity. Prices are likely to stay depressed for years to come. If the down payment was low and the borrower has only lived in the home for short time, they stand to come out ahead by mailing in the keys and getting out from under a burdensome mortgage, particularly in a no-recourse state. That $700 a month could go a long way in these difficult times.

[netsurfer2]

26. Irresponsible

If you have lost a job then it might just be the only viable option. However the person in this story has the money to pay the mortgage. He evidently feels that since his home has lost value he should walk away. All that does is further depress the housing market.

[roamer65]

25. It's a case-by case decision at this point.

Federal Reserve M1 money supply inflation is eventually going to build a floor underneath home prices and start to even cause home prices to rise, but a Big Mac meal will cost you $20 at that point...LOL.

If I were $100K down at this point, I'd throw the keys on their desk after I bought a cheap manufactured home in a nice park.