As Values Slide, Should You Walk Away?

As you know from my previous blogs, I do a lot of work with clients and the big 8 lenders, assisting with loan modifications and short sales.  I recently learned a shocking statistic from one such lender:  in 2008, 17% of all foreclosures were homeowners who could afford their mortgage payments, were current on their payments to all creditors, but chose to walk away from their homes.  In 2009, that number had risen to 1 in 4, or 25%.  Since the beginning of 2010, that number is up yet again, to a staggering 30% (almost 1 in 3).  The process of leaving one’s home is known as strategic, or elective, default. (One broker I know calls it “jingle mail”, a euphemism for the sound of the house keys being mailed to the lender.)

Clearly, elective defaults are rising, although no one can say with confidence by how much. Moreover, one of the elements that traditionally has been keeping it at bay is the sense of morality, a desire to keep one’s word.  Both the egregious misbehavior of bankers, and fact that strategic default is starting to be seen as rational, as opposed to shameful, are lowering homeowners’ inhibitions.  It is much simpler to justify an action with”everyone is doing it”, and “the lenders deserve a little of their own back”.

In addition, the real estate community has gotten on board, sometimes encouraging homeowners to walk away, rather than sell at a loss, or stay put and wait for the cycle to turn.  The point of view that a home is an “investment” first and foremost, instead of a domicile, has led people to think of it like a stock: when the market performs poorly, dump it.   Many homeowners believe they have a right to make a profit on their home.  Real estate agents have encouraged this “investment” thinking, rather than take the longer view that real estate is cyclical, and what goes up WILL go down, and up again.

In a recent article by The New York Times about strategic default, the Times argued that enough mortgages are deeply enough under water to induce solvent borrowers to think about walking away:

“New research suggests that when a home’s value falls below 75 percent of the amount owed on the mortgage, the owner starts to think hard about walking away, even if he or she has the money to keep paying….

By the third quarter of 2009, an estimated 4.5 million homeowners had reached the critical threshold, with their home’s value dropping below 75 percent of the mortgage balance.

They are stretched, aggrieved and restless. With figures released last week showing that the real estate market was stalling again, their numbers are now projected to climb to a peak of 5.1 million by June — about 10 percent of all Americans with mortgages.”

On one hand, there is a moral obligation to honor your contract.  If you owe more than your house is worth, one way or another you gambled on the real estate market and came up short.  Perhaps your timing was bad and you bought at the top of the market, or simply took a loan out on an asset that you didn’t realize was overvalued.  Perhaps you took out a home equity line of credit (HELOC) and used the money for something other than the repair and maintenance of your home; a vacation, new car, tuition, or maybe even another property. (Clearly, lenders were complicit by being willing to lend to a point where assets were over-leveraged.  Investors were complicit in the feeding frenzy for more and more mortgage backed securities.  But those are topics for another day.)

On the other hand, no one (at least not the average American) foresaw the tsunami of economic events that occurred in the past 36 months.  And now, each family must make the difficult choices to keep themselves afloat.  We are all just muddling along.  But there is a covenant that we have with our communities as well, which sometimes means making hard sacrifices along the way.

Regardless of the choices you made, it’s not your lender’s fault that your property value went down.  Expecting them to take the burden of your situation is unrealistic.  And more importantly, every other person in your community is facing the same market as you are; property values are down for them as well.

The responsibility to honor your promise to pay isn’t fungible.  If you can make your house payments, it’s the right thing to do, for yourself, your neighbors, and for your community.  Walking away is a slippery slope that results in yet another foreclosure sale, further declines in neighborhood property values, and, you guessed it, more people underwater in their home, who may walk away.

The survival of our financial system depends on everybody doing the right thing.  Imagine the consequences to the market if all borrowers that owe more than their house is worth but can afford the payments choose to walk away.  Now imagine, instead, if we all accepted the condition of the market, and waited it out.  Recovery would be faster, and we would all share in the burden.

When I sit in the living rooms of people who are suffering real hardship (loss of job, medical hardship, etc.) and who can no longer afford to make their payments, I am often moved by their true sadness and feeling of failure at having to give up their homes.  These are families who understand and treasure the privilege of home ownership.  I’m sure they would trade places with the “elective defaulter” in a heartbeat.

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