(This post is the all-time most popular post I have ever written. It is directed at those who are looking at walking away from a house they can make payments on simply because of dropping equity. On February 10, 2014 I wrote a follow-up post with some information that may help you if you are facing foreclosure because of job loss, reduction in hours, or inability to make payments because of insufficient income. That post can be accessed here.)
On Sunday our pastor decided to preach about the dismal state of the economy and how we should react to it. During the sermon, he mentioned that his brother's house is worth fifty percent of what it was purchased for and that his brother has no choice but to walk away from his home. Now, our pastor's brother is self-employed, and I don't know his specific set of circumstances; if he can no longer make the house payments on his house due to loss of income he may, in fact, have no choice but to walk away from a home he can't sell. But more and more, we are hearing that if our houses have lost value we should just "walk away" from what has turned out to be a bad investment.
On Sunday our pastor decided to preach about the dismal state of the economy and how we should react to it. During the sermon, he mentioned that his brother's house is worth fifty percent of what it was purchased for and that his brother has no choice but to walk away from his home. Now, our pastor's brother is self-employed, and I don't know his specific set of circumstances; if he can no longer make the house payments on his house due to loss of income he may, in fact, have no choice but to walk away from a home he can't sell. But more and more, we are hearing that if our houses have lost value we should just "walk away" from what has turned out to be a bad investment.
One vocal proponent of "walking away" is financial guru Suze Orman who has been quoted in numerous articles stating that those who are "underwater" in their mortgages should walk off and let the houses get foreclosed on. This past Monday, Ms. Orman appeared on "The View" with what has become her new rallying cry, "If you are upside down in your mortgage and the bank will not work with you, walk away from the house."
In Orman's book The Money Class, she advises borrowers, "Do the calculations everybody. How much is it costing you to actually stay in that house? How many years will it take for you to pay more for that house than it is worth? If it's 3 years, 4 years, 5 years, are you kidding me? That's a house you really need to say bye bye. It's not worth the money." Orman advises people who are upside down in their home mortgages to try to get the bank to modify the loan. Failing that, she says that homeowners should seek out a short sale or a deed in lieu of foreclosure. "If they won't do that, then walk away. It's just how it is."
The fact that a respected money expert is telling American borrowers that they can and should default on their loan obligations when they have the ability to repay is really a sign of just how far we have fallen as a nation. It is deplorable to think that we have come to a place as a society where defaulting on our obligations is considered some kind of a moral high road.
CBS Sacramento carried a story on April 28, 2011 of borrowers who did just as Orman suggests and let their homes go into foreclosure because they no longer have the equity they once did. Mary Beth and Bob Stucky were underwater $200,000 and the bank refused to reduce the principal, so they walked away and became renters. They are now renting a larger house for a smaller payment, and although they may not be able to buy a home again for many years, they say they feel "peaceful" because they realize that their home was a "bad investment." CBS Sacramento also interviewed Rob Sorenson who walked away from his home and allowed it to go into foreclosure. All of his credit had previously been good, but his decision to allow his home to be foreclosed on resulted in his having all of his credit cards cancelled so that when his dog got sick and had to go to the vet he had actually had to borrow $2000.00 from a family member since he does not have any access to credit. So he has not only defaulted on a major obligation, but he has actually become a burden to family members who are having to loan him money that he used to be able to borrow on his own.
Other than the nuisance factor, what is really wrong with walking away from a home that is underwater? Plenty. For one thing, it doesn't make any sense. If you have a fixed rate, fully amortized mortgage for thirty years, or fifteen years, or twenty years, you know at the time that you sign the mortgage documents how much your monthly payment will be and also how much you will be paying for that home. The truth in lending document included in every mortgage package contains the exact dollar amount you can expect to pay for that loan over the life of your mortgage, and it is normally two to three times higher than the amount you borrowed due to interest and finance charges. So in that sense, every mortgage holder is upside down on his or her mortgage when they sign the papers. But if you have not suffered a job loss, a health crisis, or a financial tragedy, you have no reason not to make those payments. Why? Because the appreciation or depreciation on the house is just a number that changes arbitrarily. When properties were appreciating at a skyrocketing pace, no homeowner ever went back to their mortgage company and said, "I know I bought this house for $200,000 and I financed $150,000 but now it is worth $500,000.00 so I think I owe you some additional money." So why, in the reverse situation, should the bank lower your principal simply because the value has dropped? You didn't owe them more when the values were rising, and you don't owe them less now.
If we had no moral obligation to pay for things that depreciated, no one would ever make a car payment again. Virtually everyone understands that the moment they drive their car off the lot, it has less value than it did twenty minutes before when it was sitting on the lot. If we applied the same logic to all items as we do to homes, we could not have any credit system at all since the moment that something became old or worn we would no longer need to make the payments. The problem with housing is that we no longer look at our homes as a place to live. We have decided as a society that our houses are supposed to contain enough equity to pay for our summer vacations and to give us a credit card to spend on whatever we wish during the year. If the house can no longer be a source of free fun money, it has failed us and we should not have to pay for it.
Second, the boom was artificial, and so is the bust. When real estate values were booming, we all seemed to forget the basic principles of gravity "What goes up must come down." Right now we are in a double dip, and values are dropping this summer and will continue to drop for a while as underwriting guidelines continue to tighten. But, after that, we can look for values to rise again as properties become more expensive. That house that today is worth $200,000 less than it was 4 years ago may have regained its losses in 5 to 10 years. In any event, when you walk away from a home you are making the payments on, you are throwing away all of the money you have already put into that home, which is ridiculous.
Third, although some people are forced into foreclosure by financial circumstances, many have other options. Most borrowers who are practicing strategic defaults have high credit scores and have not suffered a job loss. They simply do not see the value in making their payments. If you want to move into a cheaper house fine--how about renting your current home to someone else? As more and more people are forced to become renters, the demand for rental housing is going to grow. For a little effort, you can save your property and your credit.
Fourth, odds are very good that the house you are walking away from today may well be your last. As underwriting guidelines continue to tighten, many homeowners who have abandoned their homes for no reason are going to be shut out of homeownership in the future, either by much higher interest rates and financing costs, or by credit guidelines that do not give them a second chance. And Orman actually knows this. She says that the new American dream may not include ever owning a home again. "And if you do rent for the rest of your life, it's not a big deal. Who cares? Just invest that money you would've put in your home somewhere else....The new American dream really is a dream that allows you to sleep at night where you feel secure, and you know what is yours cannot be taken away again, because of the actions of others."
That's just nonsense. Orman acts as if strategic defaulters go off to a happy paradise with no more problems. Renters make the payments on properties that other people own and put wealth in the pockets of property owners--period. And while "what is yours cannot be taken away again" what is not yours certainly can be. Your landlord can lose the house you are renting to foreclosure if he does not make the payments regardless of whether you are making your payments to him or not. Or you can find yourself in the same situation as a woman who recently called me to tell me that her landlord is not renewing her lease because the landlord has decided to give her house to her own son and evict the tenant. Life does not come with guarantees, whether you rent or own.
Finally, homeownership provides security for people in their senior years. While young couples in their thirties and forties may not feel the pinch of renting, older Americans have typically relied on having their homes paid off as part of their retirement. A home that is paid off is good security towards any financial crisis, and many communities now protect seniors against out of control property taxes. Reverse mortgages provide seniors with the option of using the equity in their homes to offset living costs or to get rid of a mortgage payment that is too high. A home that is owned free and clear provides a senior with many options that a renter simply will never experience.
Orman is pushing all of those unhappy homeowners out there to hurry up and default sooner rather than later since the federal tax break for foreclosures and short sales will expire at the end of 2012. That would mean that if you default on $100,000 debt in 2013, you owe federal income taxes on $100,000. So in addition to ruining your credit and your future homeownership chances, you will owe a massive tax penalty to the IRS.
If you have lost your job, experienced a divorce resulting in loss of income, or gone through some other life changing experience beyond your control that has cost you your home, don't beat yourself up. Life happens. But if you are considering strategic default because your home is not worth what it used to be, don't be fooled by this concept that you are going to be better off "letting the house go." In the end, you will be better off if you act responsibly and meet your obligations--either by continuing to make the payments or finding a tenant who can make them for you. A few years down the road, when values have recovered and houses are very difficult to purchase, you will be glad you held on to your property.
Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books. For more information, visit her website at http://www.frontier2000.net.
omg, you really are clueless. walking away from a home, when one is underwater and can't pay, is not the same as "never making another car payment again." guess what, if you stop paying on your car, it gets repossessed. same with the house. it's a business decision, not a moral one.
ReplyDeletei used to be like you, judging everyone who went into foreclosure. you need to see things from another perspective, or at least understand that many have circumstances you *don't* understand. most of these people were sold a bad product.
The American people have bailed out the largest banks in the world. Why should we pay any mortgages?
ReplyDeleteBank bailouts from TARP have absolutely nothing to do with your contractual obligation to pay your mortgage.
ReplyDeleteThe contract spells out the eventualities of a failure to pay. The bank gets the house. There is no morality clause. It is an efficient breach of contract and businesses do it quite regularly, including Morgan Stanley, the Mortgage Banker's Association, Tishman Speyers, etc. There should be no double standard. The Banks should be willing to work with homeowners instead of shifting the entire burden to them. I also see you went to BYU, so ask yourself, WWJD?
ReplyDeleteJesus did not have a house, but if He had,He woudl have paid for it. The Bible says to keep your word even if it ruins you. The contract spells out that if you default, the bank takes the house, but unless you have at least 30% equity in the house, they lose money when they foreclose after they pay the attorneys fees. There is absolutely no excuse for defaulting if you can pay. The fact that big corporations steal money and leave other people holding the bag doesn't make it right.
ReplyDeleteAgain you show your lack of legal understanding. You sign a contract to pay for a house but if you don't pay the Bank gets the house. That is following "your word." Keeping your word if if ruins you? Absolutism is silly. Jesus would a) forgive people for "the sin" of acting to protect their families and future and b) if he was the bank would work with people instead of cramming the problems down their throat. Third, the fact that Corporations do it DOES make it right, both Morally and Legally. Fourth, the argument about equity and costs of foreclosure are not in the contract, they are risks born by the Bank. They assumed the house would be sufficient collateral. They underwrote the loan. They were wrong. It is not the former homeowners fault.
ReplyDeleteFinally, ask yourself, if you were underwater on a home by 50% and continuing to pay a mortgage meant your children would suffer for the rest of your and their life because of a stupid mistake made by millions of Americans, that you would continue to pay. Again, WWJD?
Suzie is RIGHT.
If you have a fixed rate 30 year mortgage, making the payments will not ruin your life or cause your children to suffer since at the end of the term the house will be paid for and then you will own it free and clear. There is no way to pretend that defaulting on credit is a moral high ground--it's not. If I had children, I would want to set a good example for them by paying my bills. I think Jesus would want that too.
ReplyDeleteTo ALL: ALWAYS THINK about what is in it (what profit or gain can be made) for the person who says a certain statement...for example, can you think of ANY sort of gain being made for any of the above commentors? (For example, it's easy to think that maybe "Alexandra Swann" either works for a bank or has a close relative who does...on the other hand, I can't think of ANYTHING "Anonymous" would gain from HIS/HER comments, other than feeling good about spreading FACTS in order to actually HELP others!!!)
ReplyDeleteFirst of all, your existing credit cards will NOT be cancelled due to your foreclosure (as A. Swann stated)! And, OF COURSE continuing to pay your mortgage will ruin your and your children's lives, since you will eventually end up foreclosing in the end anyway, but with LESS $ in your pocket (than if you had walked away earlier)! As for MORALITY...
ReplyDeleteIn the business world, strategic default is a common tactic – considered a savvy move for financially troubled companies. However, “consumers have been browbeaten and trained to believe that it’s not honorable to not pay your debts,” said Margery Golant, a Boca Raton attorney who represents the Pompano Beach couple in default. “Why should it be any different for consumers?”
Last year, Morgan Stanley walked away from a $1.5 billion mortgage on five buildings in San Francisco despite record-breaking profits in 2009. Real estate giant Tishman Speyer Properties strategically defaulted on $4.4 billion in loans on two housing developments in New York after the properties lost $2.2 billion in value. The company had billions of dollars in assets, including Rockefeller Center and the Chrysler Building, which it could have leveraged to meet its loan obligations.
Even the Mortgage Bankers Association, whose president chastised homeowners who strategically default for the “message” it would send to their “family, kids and friends,” dumped its Washington headquarters in a short sale. After working out a deal with its lender, the MBA sold the building for $41.3 million last year. In 2007, the group purchased it for $79 million .
“No, it’s not wrong,” said Randy Cohen, author of the weekly Ethicist column in The New York Times. Although homeowners are emotionally attached to their property, a house is still an investment. “I don’t understand why you would be asked to make a decision on this investment any differently than you would on any other,” Cohen said. “Why should homeowners be held to a higher ethical standard?”
Thank you for this article. My husband was advocating dropping our house simply because if we sold it for a loss we would pay taxes on it come Jan 2013.
ReplyDeleteFrom what I am reading that is only if we sell it at a loss and the debt is forgiven and then it becomes DDI.
If we keep renting it (it was worth 115K when we bought it, we owe about 98K now, and it's worth 75K), our rent is the amount of our mortgage payment, we should be fine if we keep renting it till we can reduce the mortgage debt enough to sell it for no loss or gain. right?
Also if our renters want to buy, if it is valued at 79K but they want to (107K tax value is unchanged) buy it for what we owe, is that possible?
Thanks,
As I understand it you are correct. If you keep renting it for enough to cover the payment you can sell it for the balance/value on it and not owe any tax.
ReplyDeleteAs far as selling it now for what you owe, that is certainly possible as long as the buyer can pay cash for the difference between the appraised value and the sales price. If your buyer is seeking financing on the house, and the value is $79K and the price is $98K, their loan amount will be based on the appraised value rather than the sales price. So depending on their situation, they might need to go on renting for a while until the values stabilize some. But after the values start going up, the home's value and the amount you owe will coincide pretty quickly.
Hope this helps.
Thank you so much. So I guess the Tax value holds no weight when financing. I was hoping it would.
ReplyDeleteThanks again.
We bought our house for 360,000 in 2005. The house is now worth approx 200,000. We have owe 300,000(263 and 35 HE). Our loan was a 5/1, which has started to adjust. We can afford the payments, but will be retiring in 10-12 years. We would like to refinance to a 15 yr, but the bank won't work with us because we are underwater. We don't want to walk because we weren't raised that way and don't want to ruin our credit. What would you do?
ReplyDeleteThat is a very difficult situation. This is what I would do: Since you have the money to make the payment and you want to be on a 15 year note, you can amortize the shorter note yourself. First, look at how much your current interest rate is now. Next, if you have been paying for 5 years, you have about 25 years left on your note. Use an on line calculator to figure out using your current interest rate and principle owed how much additional you need to pay to pay the note off in 15 years. Then make your regular payments and send the additional money toward principle.
ReplyDeleteMaking this extra payment will allow you to save a lot of interest. It will also allow you to start paying down your principle which will help you to begin to overcome the shortfall between what the house is worth and what you owe on it.
Sometimes making additional principle payments is actually a better optiont than refinancing because you don't have any more costs--you just pay against what you owe.
In spite of what some people are saying, real estate values will rise again, so when they do you can take advantage of the lower balance owed and the increased equity to refinance at that time if the rates are good.
Hope this helps.
You make a valiant effort in bleeding the lines between contractual and moral obligations, but in doing so, you cheapen ACTUAL moral obligations. Walking away from a home is a financial decision, not a moral one. The banks are not putting their morality on the line with the closure of a contract, so holding consumers morally accountable is unfair and manipulative. Your article reeks of ignorance (not all situations are as black and white as you presume) and self righteousness (there is only one person who is able to judge morality and it's not you).
ReplyDeleteOh Vomit Alexandra. If your interest induced loan that increased past your monthly income level...then you should morally still pay your loan. My sisters loan payment now exceeds her monthly income because it was adjustable. Maybe she can go to her employer and get an ARS...adjustable rate salary that increases when her loan increases. My advice to YOU....Don't advise people on what to do with finances....go to church and play the organ or ring the bells.
ReplyDeleteNice.
DeleteSuzie Orman makes the point that the reason so many houses are underwater is because of corporate crime. The corporate crime of making so many bad, sub prime loans and then Wall Street bundling them and not correctly appraising the bundles. Many home owners are victims of corporate crime.
ReplyDelete...It is sad that we have so many people who have no morals...walk away by Suze Orman is simply an excuse for many to not pay their bills and is irresponsible...yes, some who lost their jobs may have no choice... but being underwater in a bad economy is an ecuse to lute & steal like you see on the news, no different than other mob mentality..
ReplyDeleteThere is no morality clause in any of the contracts that the banks issued. That being said people should weigh the benefits versus the detriments when deciding to walk. High payment, underwater, better deal renting...Walk! Treat the decision as a business decision, not a "We love our Home" decision, that will possibly hurt you financially for many years to come. If the lenders placed morality clauses in their notes, we would expect them to be morally responsible and do the right thing and we know they aren't and continue to not do the right thing.
ReplyDeleteAnyone still paying their underwater mortgage has to have their head examined. The banks are stealing money from you and you are too stupid to realize it. I will explain this to your wife and she will divorce you for being so stupid.
ReplyDeleteThe goverment bailed out the banks with our tax dollars after they illegally bet on and defaulted on shady investment strategies with our mortgages. These same banks contributed hundreds of millions of $'s electing our president, who placed some of these CEO's on his cabinent. Members of congress make millions with non public ivestment information. The homeowner can't simply scrape a living from all this mess. But laws offer a financial advantage against the financial and govermental crooks of our generation. People are going to find ways to fight back. We will stand up on our hind legs and change this country. The # of those taking advantage of Strategic defaults, walking on Wall Street is just the beginning...
ReplyDeleteYou do realize that bankruptcy is from the Bible? So, apparently, filing bankruptcy is okay, but simply breaching your mortgage contract is immoral? Please! Yes, you really do need to get a clue. It is not a moral issue. It is a simple cost-benefit analysis and the banks would be the first to walk away if they were in our shoes.
ReplyDeleteYou are expressing righteous indignation and you are using religious scripture inappropriately. "Judge ye not less ye be judged." Whatever those who see fit do is their business and none of yours. Be sure that you do not find yourself making the same decisions. Every time you judge it will be counted against you. And in these times so many people will find themselves eating their own words. What has been committed by the banks follows this dictate which I am sure you understand and know: Ye reap what ye sow." and "Greed makes one loose all." So according to yours and the Proverbs moral dictates the banks are getting their just deserts. 'What goes around comes around.' So why not see that part of the moral story and not just the side that the Pharisees and Sadducees saw. Since you are so religiously versed if you recall it was the poor that Jesus sided with as the rich, powerful and merciless church members who often broke with the law would hold it over the heads of the poor and disenfranchised. Watch yourself, you are crossing dangerous moral and religious ground. You too must face the Master and you too will be held accountable about all your actions. Worry about your own soul and stop judging those that don't belong to you.
ReplyDeleteHooray to you Slavetothemachine!!!
ReplyDeleteApparently the whole point of your post is to rant about Suze Orman.
ReplyDeleteWhat about your holier than thou Pastor who was preaching the same thing?
Such a hypocrite you are.
Suckers - the banks are doing business and the rest of us are evaluating moral nuances of doing business. We all thought borrowing money on 80-90% of an appreciating asset was okay. Turns out the value of homes was willfully inflated by the lending industry. We had no way of knowing mortgage lending had become a ponzie scheme and now a preacher tells us we have to proceed as lambs to the slaughter at the hands of the criminals - the banks.
ReplyDeleteIts just business and the banks that live by the sword should die by the sword. Of course they will not because the government (and tax exempt churches) will defend and enrich banks over homeowners.
Do yourself a favor and listen to Suze
Excellent! Your eyes are wide open my friend.
DeleteMany of your points about the fallout of a strategic default are good ones. But you fail to acknowledge a significant change in the business of home ownership in recent years: The culpability of banks and investment firms for the mess we are all in now.
ReplyDeleteIt was big banking that caused the plunge in home equity by making subprime loans using shoddy practices and then securitizing those loans to make even more money on them. Then, when their actions pushed them close to ruin, taxpayers bailed them out. Now those same banks expect the taxpayers who bailed them out to ALSO honor underwater mortages EVEN WHEN, in some cases, they cannot refinance to a lower interest rate. To add insult to injury, some of the programs put in place to help homeowners--HAMP and HARP--are being paid for by taxpayers, NOT the banks who caused the mess.
Banks should have to take their medicine like the rest of us. With reasoning like yours, their malfeasance will only be rewarded by responsible borrowers who made all the right moves, but are stuck in underwater mortgages that cannot be refinanced.
If banks offered refinancing or a mortage adjustment to all their underwater borrowers without being paid for it by HAMP or HARP, I might agree with the "moral obligation" angle--and some banks are, indeed, participating in the recent national mortgage settlement. But not all of them are doing so, Fannie Mae being a notable example. Banks treat a mortgage as an investment. Why shouldn't homeowners do the same? Suze wins this one.
We cannot just blame the banks for the fallout and the shoddy practices. It's never quite that one-sided. How about the people who applied for loans they could not afford? And please don't claim they were ignorant. I have always known exactly how much we make and no salesman in the world will sell me something out of my price point, no matter how creative they get with their financing. The bottom line is, many people want things they can't afford and spend much more than their income warrants. It's sad but it's true. For some people the American dream of the house with the picket fence is just that, a dream. Come back down to earth, focus on your goal, be ruthless about saving your money, shop within your mean when purchasing a home. And if all you can afford is a condo with white appliances and formica tops, so be it! Home, sweet, home which you can make a home!
ReplyDeleteThe problem is Alexandra's faith is Jesus Christ while most others put their faith in this world and in money. These two types of minds will never meet.
ReplyDeleteIt took courage to write this article. To say that Suze Orman, a well known, well respected financial guru is wrong is not easy task. I agree with Alexandra.
It used to be that man's word was good. Then a handshake. Then a signature. Now what? Our first born? If we lose our sense of responsibility when we take a risk and if we blame others when no one held a gun to our head and we were in our sound mind then what comes next? Jesus says, "Those who have ear will hear."
Nice foreclosure advice. Wish I was in the market to purchase a new home...
ReplyDelete-Jon