Not Walking Away from Underwater Mortgage Is for Suckers-and People Who Aren’t Rich

I’ve mentioned before how the decision to walk away from a mortgage that costs more than your house is worth (‘strategic default‘) should be based on how that decision affects you financially (and, of course, if you want to stay in the house anyway). In an environment where loans were approved such that there could be a strong incentive to walk away, there’s no ethical issue–caveat mutuor. So I find this NY Times report very interesting:

Whether it is their residence, a second home or a house bought as an investment, the rich have stopped paying the mortgage at a rate that greatly exceeds the rest of the population.

More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic.

By contrast, homeowners with less lavish housing are much more likely to keep writing checks to their lender. About one in 12 mortgages below the million-dollar mark is delinquent.

Though it is hard to prove, the CoreLogic data suggest that many of the well-to-do are purposely dumping their financially draining properties, just as they would any sour investment.

“The rich are different: they are more ruthless,” said Sam Khater, CoreLogic’s senior economist.


I don’t think they’re more ruthless, just less intimidated by other wealthy people, and, like wealthy people everyone, less bound by convention–the rich don’t have to be bourgeois. And make no mistake about it, screwing over your future out of some misplaced belief that those to whom you owe the money will behave benevolently is the sucker’s play:

The rich and successful come naturally to this attitude because they understand how contracts work and don’t get hung up on the Calvinistic notion that they should destroy themselves rather than return a piece of property to a bank.

Banks don’t “feel” and they have no morals. They hold all the power to foreclose on you when you can’t pay and exercise it without emotion. If it is in their interest to renegotiate they will try to do it. If it isn’t, they won’t. Corporations are required by law to act this way on behalf of their shareholders. As long as that is true, then the all the parties to these contracts have no choice but to do the same thing. It’s just a financial transaction not a religious rite. This is a rigged game for average Americans and they should wise up.

While I realize regulation has become a four-letter word, regulation does force the regulated to act in certain ways that they would otherwise not. To the extent we want an ethical economic system, it needs to be structured and enforced in order to remove incentives and advantages for unethical (or ‘athetical’) behavior.

But I realize that would be like totally Hitler.

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17 Responses to Not Walking Away from Underwater Mortgage Is for Suckers-and People Who Aren’t Rich

  1. Russell says:

    The good news from the painful transition is that we may return to the days past when buyers had to put 20% down to purchase a house, when house prices were lower than they are today, and when people looked at houses more for utility than for ostentation. Oh, and drop the friggin’ idiocy of subsidizing home ownership.

  2. cass_m says:

    Why wouldn’t rich people walk away from mortgages? As you say they are used to dealing with other rich people and nothing the truly wealthy does negatively impacts them. Look at the CEOs of the companies who impacted the world economy with their greed. They are still accepted by their peers and haven’t missed a beat.
    Wow – really you don’t have to act ethically towards debtors? Just wow.

  3. Pat Gardiner says:

    “Negative equity,” we call it in Britain and it certainly does not pay to walk away from it.
    I’d be surprised if it is that different in the US, but happy to learn of US practice.
    In Britain, the bank sells the repossessed property, usually badly, and adds any loss plus interest to the bill.
    If the borrower then can’t or won’t pay, and in the absence of a sensible deal, they make the debtor bankrupt. They may not matter much to the poor, but it matters like hell to the rich.
    Unless, of course, they have lost everything anyway!
    Pat

  4. Lyle says:

    In some states in the US the mortgage is called non recourse, which means the lender gets the house and thats the end of it (Ca and Tx among them).
    I would add that the rich are more aware of the tactics of business, and are not under the idea that there is any moral obligation of a contract. Its just a business deal, and that is that.
    As this goes futher into society, I do expect down payment requirements to go up so that folks have significant skin in the game.

  5. The rich can afford equally cut-throat lawyers and keep any property disputes tied up in the legal system indefinitely. They are very unlikely to be forced to declare bankruptcy as a result. My brother worked in construction all his life, and just lost his house and declared bankruptcy. He’s now driving a truck. He did the right thing to walk away — but it destroyed him. The rich will never have to pay that steep a cost.

  6. Pat Gardiner says:

    Ah! Thanks for that.
    I guess it might be possible to arrange a mortgage without recourse in Britain, but I can’t see the banks agreeing, although they agreed to some crazy things a while back.
    I have to say that as a former businessman, I would not like to be such today.
    “Bad money drives out good”
    The decent cannot survive against the crooked and ruthless, they get undercut, usually with bank connivence.
    Still change is now in the air, thank goodness.
    Pat

  7. becca says:

    I wonder if people who have mortgages over $1 million are also disproportionately likely to be in the situation of having their property values drop a much greater percentage. If you have a $150,000 mortgage on a home that is now worth $120,000, it makes more sense to keep paying it off than if you have a $1 million mortgage on a home that is now worth $250,000.

  8. JasonTD says:

    Mike,
    I agree that people should approach their mortgages like a business transaction rather than a moral obligation (since banks act that way, obviously). However, in your zeal to point this out to people you should be more careful. As Lyle pointed out in #4:

    In some states in the US the mortgage is called non recourse, which means the lender gets the house and thats the end of it (Ca and Tx among them).

    That might not be the case for everyone. You should caution people to carefully investigate and consider the consequences of walking away before they actually do it.

  9. Paul Orwin says:

    I think a couple of things are going on – i’m obviously not an expert!
    1) As Jennifer above says, the rich have the resources to protect themselves from the banks. This strikes me as analogous to why the IRS audits the middle class more frequently than the rich – or at least I remember reading something like that somewhere :). I hereby invoke the “blog comment” standard of citation ;). On a side note, the issue of walking away is somewhat complex, from what I’ve read on Calculated Risk. For example, 2nd liens are recourse in CA, if they were above the purchase price, so if you borrowed against your house to pay off Credit Cards,or buy a fancy car, you may not be able to walk away from that without declaring bankruptcy.
    2) There is probably some funny biz going on here with the definition of rich. If I bought a million dollar house in Orange County in 2005, I might have a $700,000 house now. Am I rich? Well, I’m either quite well off (with a high priced asset like that) or in deep doo-doo (Owing 100-300k more than its worth). But as becca says, being 30k in the hole is a lot different from being 300k in the hole. Although I’m not sure the percentages are that different across values, the amounts certainly get bigger. I think a 300k debt would have a lot more weight on my decisions than a 30k one (obviously this depends on income and other debt/obligation).
    As an aside, it was pretty crazy in the mid-aughts, and salaries weren’t keeping up. A lot of people probably got good jobs in inflated places like the OC or parts of the Inland Empire (CA, Riverside and San Bernardino Counties), and bought houses that they couldn’t afford because they trusted the loan officers and bankers, figuring that all the people around them were doing it, so why not? Should these people be stuck with the bill? Although I got in before the bubble, I saw some of this with colleagues in academia, and I think from my narrow perspective its hard not to sympathize – obviously they could have seen the bubble coming and rented instead, but that’s easy to say in retrospect.

  10. bellisaurius says:

    Also, one needs to factor in a poorer person who has a house will have a much tougher time getting a new house (their income stream being smaller), so they will tend to try to keep it because it could be a while before they get another.

  11. Kaleberg says:

    I remember an investment consultant I knew basically stopped paying his mortgage back in 2008. He figured, if the bank wanted to foreclose, that was their business. As was so often the case with a collateralized loan, the bank was limited to taking the house. This is typical of leveraged operations in the business world. It is the flip side of the coin on a lot of loans in which the purpose of the loan is to purchase something and that thing becomes the lender’s if the borrower doesn’t make his or her payments.
    Leverage makes a lot of sense in the business world. Suppose you want to open ten restaurants. You can save up to open all ten, or you can put up 10%, enough for one, and borrow 90%. As long as the ten units pay more than enough to cover the loan and their operating costs, you are making money, and you can make a whole lot more money with ten restaurants than one.

  12. mrcreosote says:

    Old saying:
    if you owe the bank $1,000 dollars, that’s your problem. If you owe the bank $1,000,000, that’s the bank’s problem.

  13. FrauTech says:

    Wealthier people have more options. If you don’t have a lot of cash on hand and have to forclose, you might have trouble getting credit approval to go rent an apartment somewhere. If you’re wealthier you likely have access to enough cash that you can convince the apartment place to take you without good credit (pay ahead of time, or show substantial savings instead of a good score).
    I don’t like the “there’s no ethical issue” to walking away from a home. To me that is along the same lines of if your home went up in value the bank suddenly demanding you pay them more. They aren’t entitled to extra value on the home and when you take out a loan for a house it should be in good faith. It wasn’t the bank’s responsibility to verify your home would never lose value. Now, if you lose your job or have some other financial hardship, I think it’s perfectly fine because your situation has changed and if the bank isn’t willing to work with you walk away. But becoming a society of people who accepted a loan, agreed they could pay the loan, but then decided they didn’t want to because it wasn’t “convenient” for them or because they made a bad bet is bad ethics. Dumping your loan on the “big bad” corporations is only going to hurt society and the taxpayers in the end. And think it through as well since often you won’t be able to get an apartment or mortgage company to trust you so long as it shows up on your credit history. And why should they?

  14. Troublesome Frog says:

    I don’t like the “there’s no ethical issue” to walking away from a home. To me that is along the same lines of if your home went up in value the bank suddenly demanding you pay them more.

    No, they’re not along the same lines because it was never written in the mortgage agreement that they could do that. If it was, you can bet 100% that they’d do it.
    Borrowers and lenders are always partners in a business transaction. If you make an investment with the bank as your partner and the contract stipulates that they can stick you with the bill if the it goes bad, don’t rely on the bank’s good puritan ethics to protect you. They’ll exercise that put option without batting an eyelash.
    Yes, blanket defaults hurt society as a whole, but you can’t have massive waves of defaults without massive misallocation of loanable funds. I would argue that until borrowers start acting like rational financial actors, those funds will continue to be misallocated.

  15. Runningball says:

    Alot of people (like us) could have avoided being underwater if we just knew some facts sooner. However, in trying to do ‘the right thing’ by not ‘skipping out’ on our creditors, we put ourselves in a worse situation.
    http://outrunthestagecoach.com/Meet-Kamal.html

  16. Roman says:

    @13
    “I don’t like the “there’s no ethical issue” to walking away from a home.”
    Think about it. The mortgage contract gives you a put option on the whole deal. The bank is smart enough to factor the cost of this option in the mortgage payment, so that on average (across their pool of borrowers) they make a profit. You have already paid for your right to exercise this option, so by not doing what is most profitable for you, you’re hurting yourself and not acting rationally.
    An unethical thing to do is to misrepresent facts on your mortgage application, or to pay the bank with fake money. Exercising an option which is a part of the contract is not unethical. Not exercising it when it’s profitable for you is just stupid.

  17. I strongly disagree, those who borrow MUST pay back!

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