Real estate prices have dropped about 30 percent since their
peak in 2006. As a result, something like ten million American
homeowners owe the bank more than their houses are now worth. More than
half of them are stuck with mortgages that are more than 20 percent
higher than the value of their homes. They could simply walk away from
the home, stop paying the mortgage, let the lender foreclose, and be
better off. More and more people are taking this option. Is it moral?
may not even be legal. Your mortgage contract says that you "promise to
pay" the bank however much you borrowed from it. Many states have laws
allowing mortgage lenders to pursue your other assets to get their
money back. But that can be difficult and expensive. You may even be
able to live in your house payment-free for months while the bank goes
through foreclosing on you. Then you can rent another house—possibly
one the bank unhappily repossessed from someone else who walked away.
are other practical problems: your credit rating will be trashed, and
you won’t be able to get another mortgage for a few years. Don’t be
surprised if your former neighbors don’t take kindly to the effect you
have on property values. And there are the hassles of moving under any
circumstances: new schools for the kids, and so on. But the main
deterrent is honor and shame. If you literally can’t make the payments
and still feed your family—that is, if you’re bankrupt—then these
things don’t matter. But increasingly, people are walking away from
underwater mortgages who could keep paying but choose not to. These
cases are called "strategic defaults." Can there really be any
justification other than necessity for ratting on a promise and keeping
money that you owe to others? (For a firm and eloquent “no,” see our
colleague Megan McArdle’s post
surprisingly, the answer is "yes." There are strong arguments that any
feeling of shame or dishonor about walking away from a mortgage is
misplaced. Whether these arguments are persuasive is up to you.
the bank may not be wholly innocent. Traditionally down payments are
supposed to prevent this situation from arising. The larger the down
payment, the more a “walker” is walking away from. But in the recent
real estate bubble, banks demanded smaller and smaller down payments
for larger and larger mortgages to less and less qualified buyers. They
encouraged people to take second mortgages every time their house value
increased. There was no gun to the head of the home buyer, but there
was no gun to the head of the bank, either. It was a folie a deux. Both
sides of the deal were foolish. Why shouldn’t both sides suffer when
the deal goes bad?
Lenders cannot claim to have been blindsided by defaults. Generally, lenders require borrowers to purchase Private Mortgage Insurance
if the loan is greater than 80 percent of the property’s value. This is
precisely to off-load some of the risk they are voluntarily taking on.
the financial world, companies and individuals default on loans all the
time, with no stigma. Recently the purchaser of an 11,000-unit housing
complex in Manhattan turned the keys over to its creditors and walked
away. Tishman-Speyer had paid $5.4 billion for the property late in
2006. It is now worth $1.8 billion. Dan Gross offers several other juicy examples
fact, enabling business people to walk away from debts is vital to
capitalism. The corporation was invented to facilitate this very thing.
The essence of a corporation is "limited liability." By doing business
in corporate form, the shareholders are putting everyone on notice that
their liability for the corporation’s debts is limited to the amount
they have invested. No matter how much money they may have, and no
matter how much the corporation may owe, they can never be asked for
more. No one even suggested that "honor" required the shareholders of
General Motors, their equity already wiped out, to reach into their own
pockets to make good on GM’s obligations.
On the other hand,
if many of those 10 million Americans whose mortgages are underwater
choose to walk away, it would be a catastrophe for the housing market
and probably for the economy. Some people feel that paying your
mortgage—even if the house you used it to buy is worth less than what
you owe-- is not just honorable but a patriotic duty.
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