Greedy Goblin

Monday, January 4, 2010

Walk away!

I promised some seriously wicked advice for today so here it comes! The post could not be created if William wouldn't send me a scientific study written by professor Brent T. White.

"Underwater loan" is something that has more to pay (without interest) than the loaned item worth. Typically it's housing. For example you bought a home for $400K, paid 50K cash and 40K loan capital. You have to pay $310K+interests more until the loan is over. However, due to the collapse of the housing market, a similar home is sold for $200K in your neighborhood. That make you $110K underwater. If you would pay the bank (310K) and sell your home (for 200K), you would have -110K.

Being underwater is not rare. In June 2009, more than 32% of all mortgaged properties in the U.S. were underwater. In some cities it's much higher. For example in Miami 70%!!! of the mortgages are underwater. Well, you might think "poor fellows", but they have an option!

Walking away aka "strategic default", meaning that the homeowner recognize that he's better off losing the "310K" home and buy or rent a similar home for 200K. The benefit is exactly 110K, and you can most easily see it if you assume that the guy has 200K. He can fully buy a new home, however if he stay in his old and give the 200K to the bank, the home will still have 110K loan.

The consequences of walking away vary by contract and country. In some cases the bank can take further values from you or pursue deficiency judgment. If you offered another home as security for the loan, they can take that too. However in most cases the bank can't take anything else than the underwater home and you suffer no other consequence than a ruined credit report. However it's only yours, your girlfriend or parents can still get a loan (with their good credit) and you can live there.

However most people don't walk away from their loans. According to the study, the defaults and foreclosures are not related to underwater ratio (if the city has 2x more underwater loans, it doesn't have 2x more defaults). The defaults are related to unemployment mostly, meaning that the people default only when they have no money and not when it would be a smart move.

Why? The article give several reasons. The most obvious is being bad at math. To calculate the exact profit of walking away one has to handle several factors like taxes, the expected increase or decrease of the value of the home (if the other option is renting), the costs of the worse credit report, the legal costs and chance of legal consequences later and such. However this could be circumvented by visiting a financial advisor and a lawyer.

The first social explanation is "denial of failure". The homeowner refuses to accept that he made a huge mistake by buying the home for $400K. He refuses to notice that the real value of his home (the price he could sell it) is $200K. He hopes that the overall price fall of homes somehow does not apply to his "special snowflake" home. The home being his also adds emotional value, making him believe that it's somehow more valuable than a very similar home. They may also irrationally believe that home prices will return to their old value. (However even if it's true, he'd be better off abandoning the 310K home, buying a 200K since it will also worth 400K soon). In short, the homeowner finds it emotionally impossible to even acknowledge the fact that he is underwater.

The second reason is "morality". A referenced study (read the linked article for references, I'm lazy to link them all) says that 80% of homeowners consider it immoral to strategically default and morality of the owner is the strongest factor to predict if he will default when underwater or not. Only 17% said that they would default an 50%!! underwater loan. On the other hand if they had a friend who already defaulted or the government give help to the poor who are facing defaults their moral commitment to pay vanishes.

The third reason is "shame and guilt". The people are very much unlikely to default if other people will consider them immoral or irresponsible. The main reason people afraid of foreclosures is embarrassment and humiliation. Those who suffered foreclosures are very ashamed of themselves, considering themselves complete failures. On the other hand those who have high credit rate take pride on it. They believe that this will bring them respect and honor in the society, therefore they don't want to lose it. They believe that by defaulting they will lose part of their "human worth".

The forth reason is "fear", mostly from the above. Since he has not experienced foreclosure, he imagines it to be much-much worse than it actually is. He fears of the "terrible" consequences of having a bad credit report or a bad name in the neighborhood (despite he will obviously not live there anymore). The reason for that is that socials believe that "immorality will be punished somehow", so if they strategically default (which is "immoral") they will be punished, mostly by the devastating effect of "ruined credit". The most obvious evidence for this fallacy is geographical pattern of defaults. If someone defaults, his neighbors will follow him, after seeing that it's not so bad. It leads to completely abandoned neighborhoods and completely intact ones, despite they are similar financially. This is the reason why governments give help to struggling homeowners. They save those who can't pay to prevent others from not wanting to pay.

The article quotes several governmental and media sources, including the US president who expressed their respect to those who keep paying and their contempt to those "speculators" (by Henry Paulson) who choose to default to get away from an underwater loan. The officials make huge effort to create social norms to prevent strategic defaults. These messages are mixtures of lies about the horrors of foreclosures and social pressure-nonsense (about responsibility, moral and "we belong to one group we must all make effort"). All these concerted media efforts are done for one purpose: to make the "little guys" bear all the damage of the real-estate balloon.

It was a balloon without doubt and everyone in the industry knew it. The normal price of a home is around 15 times higher than its annual rent. On the peak of home prices it was way above 20. The bankers knew it won't last. That's why they did not keep the mortgages for themselves but packed into non-transparent investments and sold them. These are the "poisoned papers". Note that the above mentioned "morals" and "values" do not apply to them. They don't have to take any responsibility for participating in the stupid buy, nor they have to act according to "we belong to one group we must all make effort".

Summary:
  • Your loan might be underwater. Consult a financial advisor to determine the current value of your purchase (mostly home, but car markets also crashed).
  • If you are underwater, you might better off walking away. Consult a lawyer about legal consequences in your country/state.
  • If you are better off, do it!
  • They will try to stop you by social nonsense, ranting about "responsibility" and "moral obligations". Give them a finger!
Of course if you walk away from 100K underwater loan, you not only save yourself 100K, you cause 100K damage to someone else. If it bothers you, you are a social, but even in this case you have no reason to worry! Who gets the damage? The bankers who:
  • lured lot of uninformed customers into bad loans
  • supported and advertised obviously bad purchases
  • sold the bad equities to other uninformed people in poisoned papers
  • "convinced" the politicians to bail them out on the cost of the taxpayers
  • paid themselves bonuses after all this.
Do you really think that you have any moral obligations towards these people? May Sara's kind word echo in your ears when you make your call: "Let hatred and rage guide your blow!"

41 comments:

Nathan said...

I just finished law school in the US and I remember one of the first classes in contracts our professor told us that breaching a contract is NOT a moral decision. It is purely a business one.

I agree that social reasons keep many people from breaching (or defaulting) on contracts that are no longer beneficial to them. If the consequences of breach are more appealing than the status quo, breach. If they are worse, from a business/financial/money point of view, don't breach. This goes for ALL contracts in my opinion, not just the "greedy banks."

Of your four reasons however, I think fear is the one that dissuades people the most. They don't understand what they're doing, they don't understand the costs and benefits, and they don't understand the consequences. They don't know, and usually don't even know how to find out.

Anonymous said...

Sound advice. I wish an entire country could do this. My country, Iceland, is now on the brink of selling itself to Holland and the UK because failed goblins drove their own bank to bankruptcy. A loan of 3.9 billion Euros + 5.5% annual interest is awaiting signature. A grand heritage for the upcoming generation...

bobturkey said...

Heh heh much harder to walk away in Australia. You'd be looking at personal bankrupcy.

Interesting study though.

Gobble gobble.

Anonymous said...

Bad loans not "bad equities". Equities are ownership interests.

Otherwise, entire post is right on the money.

SiderisAnon said...

I used to work for a foreclosure attorney. Your understanding of what happens when you walk away from a home is quite flawed. There are a number of elements you are missing. To reduce the idea to just looking at the amount you are "under water" as profit is simplistic at best.

First, getting that judgement against you for the money you owe past the sale of the house is basically automatic. You will have your credit rating destroyed until you pay it off because they are still an active debt.

Second, when you walk away, your house is foreclosed on. It will be auctioned on the courthouse steps (or where your county does the auction). You'll get far less than market price. Some houses sell for 10%.

Also, if you're mad at the bank, keep in mind that they can bid on the house, lower your debt only what they paid for it, and then sell the house for much more on the open market and make a profit off the whole thing. There are laws to control abuse, but it's perfectly legal.

Third, the bank has other options than just going after other real world property. They can seize assets of all sorts, depending on your state. They can also garnish your wages. In some states, they can basically lower your salary to minimum wage until your debt is paid. You'll also be paying for the lawyer who garnishes your wages.

Fifth, you will actually increase your debt. Filing to foreclose requires a lawyer, court costs, and a variety of other fees. In some areas, you'll have to pay these costs even if you voluntarily surrender the house. You're not lowering your debt by abandoning the property.


If you try to buy another house, as Gevlon suggests, before walking away from the first one, you could be facing criminal charges. You will also open up the option for the second house to cancel your mortgage and foreclose on that house as well.



Now, you could file for bankruptcy on the first home and try and get rid of the debt after walking away. The judge does not have to grant it and may not if you just walked away -- especially if you have any assets or income that say you could afford the payment. (The idea is that if you can afford the payment, you cannot get a bankruptcy.) If you did the trick of trying to buy a second house, your filing for bankruptcy will most likely automatically default you on that mortgage as well. (It's in the small print of your mortgage.) Since you can't prove that you can make the payment on that second home, they're going to take it away. If you can prove you can make the payment, the judge may well let them take the home and force you to pay off the older debt first.



Ultimately, there is no real "profit" from these sorts of activities unless you really cannot afford your payment and can get a bankruptcy. In the end, you're going to be paying off the entire debt and all added fees, plus the cost of collection and garnishment.

Forget the morals. It's just a poor business decision if all you're using is property values.

spinksville said...

Personal bankruptcy is also something that will sort itself out after a few years. Sometimes it is the best solution.

Anyhow, I agree with Gevlon here. Sometimes it's better to walk away, and the bank has to write it off as the cost of making stupid loans.

Gibbiex said...

I guess, not surprising, that Gev is missing a bunch of info. As a homeowner and taxpayer I'm fairly well versed on how things are supposed to work.

The typical American will buy a home at some point in their lives. They do this by putting down typically 20% of the purchase price. They raise this money by being very frugal in the beginning, or by a loan from parents, or some other source. Typically you can buy a condo for pretty cheap, like I did, hold onto it for 10 years, pay most of it off (bc its cheap) and end up with a nice down payment.

Then you move on your starter house. You may be there 4 years or whatever, but your condo sale is enough to pay for the down payment.

Now, if you want to buy another house down the line, you need both good credit and a down payment. You do this by making loan payments (duh) and hopefully by maturation.

For example, practicalities. We bought our home for 250k. We put 20% down, which is about 50k, so the loan was about 200k. Now we already have 50k minus about 7% for fees, so if we turn around today and sell our house at 250k we'd get 43k back. The home has to either appreciate or you have to be there for a few years to get the money back, and each sale is a cascade.

If you are underwater, you can be in serious trouble. My brother was underwater by 50%, and decided to not pay (goblinish thinking), even though he could. The bank finally said, okay, pay us a small amount, put it on the market. when it sells we get all of the money, and you walk away. Now, that'sa great deal for him. He lost his downpayment though, so he'll have to find some way to come up with 40-50k if he wants a home. But more important, his credit is ruined (remember he stopped paying). So he can forget about buying a home in his name for a while.

Now if you default, that's pretty bad and it stays on your record a very long time. Again, good luck getting a loan with your name on it.

So, yeah its not the end of the world, but home ownership has alot of advantages. You can deduct some of the mortgage interest. Your payments go to reducing the loan principle, giving you more money. Improvements you do can increase the value of your house. Over time most homes appreciate in value, and you can gain a good deal of money (my parents have some 300k in equity in their house). All of this you can forget if you default.

Eaten by a Grue said...

Under most mortgage loan agreements (remember, the banks draws up the agreement), if you default, the bank can come after you for the difference between what you owe and what the house fetches at auction.

The problem is that most people who default on their mortgages are otherwise judgment proof, so in practice, they walk away and that's it, and the bank does not bother suing.

But you need to be careful.

Also, I am curious. At what point does this "screw everyone else" ideology cross over into something that you wouldn't actually do?

For example, what about theft, assuming you had a foolproof way to get away with it. Would you steal from a bank at zero risk to yourself? Or would you feel bad, like a social, and give the bank a break?

Do you believe in any kind of morals, or is it just look out for number one?

I know that a mortgage agreement is a business deal, and breaking a contract is not quite the same a breaking a promise to a friend, but this raises the question in my mind, would Gevlon even feel guilty about that, beyond making the calculus that if he angers his friend he would lose the friend and thereby be hurt. Anything beyond that?

Dan said...

This is good advice, but before I would even consider walking away from a mortgage even if it was underwater, I would consult with a tax professional (probably a CPA), a loan modification specialist (a lawyer) and learn my rights, privileges and options, as well as what I can and cannot do.
Granted my own personal situation is going to be vastly different than the common US homeowner because my family owns 3 homes, I would automatically consult the professional opinion of a real estate expert if this situation ever happens to me, which would likely take an act of God to produce.

Gevlon said...

@SiderisAnon: there is a pretty simple way to dodge deficiency judgement: divorce (assuming that you are the only loaner and not both of you).

(Real) divorce is the second most common reason for non-strategic defaults (after unemployment). People get their mortgage with the assumption that 2 people will pay it. As soon as their wife (who is legally unbound) walks away, taking usually serious part of the wealth, he cannot pay the mortgage.

You can easily simulate it by divorcing under the terms that the wife gets everything else, and you get the "$400K" home. She can even get a nice spousal support judgment, sucking up most of your salary. After all, she left the home she helped to build!

Now, you keep paying the mortgage 1-2 months after divorce and then stop. After the first warning letter you show up in the bank unshaved, with light scent of cheap liquor and the divorce papers. My guess: they will suggest to sell off your home ASAP, and won't bother to seek you any time later.

Then you can move in to your ex-wife's brand new home what she gained with her untouched credit report.

Of course it's not risk-free, as your ex-wife can easily can get away with the money. But hey, it was YOU who signed the underwater contract. You must choose whose mercy you'd be: in the banks or in the mother of your children!

@Eaten by a grue: show me a way to steal the banks money safely and you'll see me running that way.

And yes, I'd dump the friend if it would be profitable. Oh wait, all my friends know that, so none of them give me loan, strike that since I know they are not idiots, I don't even bother asking them.

Ian said...

Walking away is often a good idea (there are even advocacy sites for it, such as http://www.youwalkaway.com/ ), but treating it as a profitable decision is really kind of a bit off-base, as other people have already noted. Being denied credit for pretty much anything isn't The End, like the powers that be would have you believe, but things work a bit differently when everything has to come from your cash on hand.

I would like to counter that the suggestion that homes typically appreciate in value and should be treated as a valuable investment opportunity (arguing that you should keep your underwater house so you can continue playing the house-investment ladder game) is reaching a bit far the other direction, though. Modern home pricing behavior has been based entirely on ever-expanding debt. While most mainstream thought is that the debt can continue to expand forever, two years ago mainstream thought was that housing prices would expand forever, and that housing prices never go down. Now we are having a discussion about prices going down so far that people end up 50% or more underwater - think about how quickly mainstream thought ended up extremely wrong. If the mainstream can be wrong for 5+ years and then have things collapse overnight once, it can happen again!

I also make the argument that playing the housing ladder game is meant to make sure that a typical citizen has as little spare money on hand as possible, ever. Once you've paid off the house it's important to sell and move up the ladder, or you do not get the (reasonably large) tax break for being in the process of paying a mortgage. It's a mystery to me why the cultural collective opinion of my nation is that paying 7% or worse on an ever-more-expensive house is an important path to life happiness. Not to mention that everyone seems to agree that any spare money left over after paying the monthly bills and buying necessities, must immediately be poured into housing "improvements" - in quotes because the style changes every 3-4 years.

Those persons who should least be sucked into spending everything (above their paltry savings withholding) seem to be the main target of the "HOUSE IS ALL-IMPORTANT LIFE INVESTMENT" zeitgeist, and the moment anything goes seriously wrong it all goes to shit because they were buying essential granite counter-top upgrades instead of socking away cash for an eventuality like crippling sickness (the kind that leads to the lost job->lost insurance->savings disappear chain of events).

I see the whole "walk away" dilemma, and the people who have it right now, as an opportunity for people in the bottom 80% to wake up and stop running in circles. I fully expect that most of them won't.

Pharoahe said...

Anonymouse, I have no sympathy for Iceland. Whilst I agree with Gevlon's article, Iceland cannot apply this rule to itself because it is not taking money from greedy bankers, but ordinary people.
Iceland can also not afford to default a loan if it is to join the EU. For you the correct business solution is to pay the loan back.

Anonymous said...

When you say "Friends" you mean the ppl you agree to be in contact with because someday you may need one of them ?

Because I don't see how you could have friends, it does not fit in your logic.

Anonymous said...

@SiderisAnon
Thanks for clearing things up for people. My wife is huissier de justice (kind of foreclosure attorney in my country) and believe me, she has very broad range of tools at her disposal to get money back for a bank or at least make debtor's life very miserable trying. And Gevlon, divorce only slows the process, you need to have savvy lawyer and be determined to dodge law and suffer minor (or not so minor) consequences for a looong time if you want to get out of this in one piece. Bankruptcy is usually only viable option, but its not painless itself and not always possible.
So, all in all, keep dreaming about playing Rob Roy and robbing evil banks of your own money.

Euripides said...

I must say, Gevlon, that this is by far my all time favorite non-WoW post. I actually agree with you, for once :)

Anonymous said...

We're underwater but decided to stay for 2 reasons that you didn't mention. The first is that we are in an incredible school district (so good that we pulled our kids out of private school to attend the public school...they killed the privates in test scores and other metrics). The second reason was the willingness of the lending institution to recognize the situation and renegotiate the loan. The didn't want the house back and we didn't want to leave. My family is very lucky and we recognize that, but your readers may want to call the lenders and say "work with me or else".

Gold NoScripts said...

I work in the mortgage industry so I feel a need to speak up here.
Walking away isn't the easy way out. Don't expect to be profiting from it.

In Gevlon's scenario he proposes getting financing for a new house, moving in and then letting the old mortgage default. By doing this Gevlon is avoiding the loss of his properties value, and letting the bank take the hit.

First this is incorrect, if the bank does foreclose they can also file a collection for the difference. Everyone assumes bad credit falls off your report in 7-10 years, this is also not true as banks sell to collection agencys who sell to collection agencys until one collection agency finally gets paid. Each new collection account on your report starts that 7-10 year timer over. You will never get a mortgage ever with a 110k collection account on your report.

Second, Gevlon proposed buying the new house and when the market returns to normal he will be able to sell it for a profit. Yes, this is true but considering the current credit environment (banks are very strict, and tight as far as your debt to income goes) Gevlon will need to be able to show the new bank he can support both the new mortgage payment and the old mortgage payment. If this is the case the SMARTEST finanical option is to keep both properties and sell them both when the market returns to normal.

Also home ownership is kind of a joke, that 200k Gevlon thought he was profiting doesn't exsist. As long as he is like most home buyers/sellers and wishes to move into a similar home after he sells his current home Gevlon will be paying another 200k on the value of a new home....because that house also went up in value. The only way to escape this cycle is to move to a cheaper market, rent, or take a house that has a lesser market value, so basically downgrading your own home for profit. One could also sell an extra property to make a profit, but that is still downgrading assets.

Let's not forget that walking away means loosing your HOME. I personally value my home more then I value a piece of property. This is true of most homeowners who think their 200k house with worth 750k. I see it all the time. Unless you can't afford your payment, or you are moving....walking away is never a good idea.

Anonymous said...

I thought I should clarify some of the thoughts from the article you are basing your post on. The article is NOT a scientific study. It is not posted by a economist nor is it posted by a psychologist, although it does make some judgements which should be reserved to those in the respective fields. This is actually a 'Discussion Paper,' which wikipedia defines as:

"a tentative government report of a proposal without any commitment to action; the first step in changing the law."

This is a paper from Arizona Law School which seeks to change the laws of the United states or Arizona. There is some research involved, but it is not anything that is based on empirical data, and this should be noted.

As for you and this blog, you cannot make statistical arguments without data to back up your claims. Did you see how many citations are in this paper? It's because it's for discussion, and the author did not do ANY research on his own and had to use other authors' data - if you want to continue to make claims about "divorce being the second largest cause for default" and other claims, then you need to make some citations of your own as well.

Talderas said...

@Gibbiex

"So, yeah its not the end of the world, but home ownership has alot of advantages. You can deduct some of the mortgage interest. Your payments go to reducing the loan principle, giving you more money. Improvements you do can increase the value of your house. Over time most homes appreciate in value, and you can gain a good deal of money (my parents have some 300k in equity in their house). All of this you can forget if you default."

Mortgage Interest Deduction: This advantage is only viable because of the M&S in government that force you to give up significant portions of your income so that they can transfer that wealth to other individuals. If goblins ran the government, the deduction would be a moot point as your taxes would drop well below what you get back from the deduction.

Payments to Reducing Principle: Unless you have excessive liquid assets lying around doing nothing, paying more than the minimum payment (assuming minimum payment does pay some principle) on a loan with an appreciating asset is pointless and stupid. That’s less money you have to work with that could be put to use making you more money. However this isn’t the same for assets that depreciate (cars) or assets that don’t have a tangible value (student loans). I’m paying about 133% of what I need to pay for my student loan. My loan is set to be paid in 20 years based on minimum payment, however assuming I’m not being screwed over by the bank in some fashion, my last payment will be Aug’18 instead of Aug’28. I pay about 33% more each month and I shave 50% off of how long I hold the debt. Student loans are a no brainer about paying more than necessary, you don’t have something to sell. With cars and other depreciating assets, you should try make sure you pay off the loan so that the car’s trade-in value at least covers the remaining principle on the car loan.

Equity: If you have equity on a home then you aren’t underwater, simple as that. There’s no advantage or point to walking away from the home and defaulting on the loan. This strategy works only because the amount owed on the home greatly exceeds its value. If you have equity, then that is how much money you will have left over if you were to sell your house today and repay the loan.

The issue that led to people walking away from their homes was that they got a loan for nearly 100% of the home’s value, let’s say 100k for argument. Any sane and rational person would want to put around 20% down on a home if you mortgage. Now this person had a 100k loan on a home was making minimum payments which either paid a very small portion of principle or was just paying interest accrued. Let’s say he’s paid 5k of the principle when the event occurred. He has a 95k loan on a 100k home (giving him 5k equity), when the value of him home plummeted by 25%. Suddenly he has a 95k loan on a 75k home (making his equity essentially –20k). Now, if the individual had put 20k down initially, he would have a 75k loan on a 75k home and have no equity. This is precisely why you put around 20% down on a home. This way you have a nice cushion incase the value of the home drops.

csdx said...

Strangely enough I've written a similar post to this as well. The main comparison people should think about: cell phone contracts. No one likes early termination fees, but hey you signed the 2 year plan, so it's almost just like a mortgage.

But I think the biggest factor about not wanting to give up on a house is that it, well, is a house. So the amount of time and effort someone's invested into it likely is quite a bit, and they're likely to value that sunk cost quite highly and not want to give up.

Of course we know that sunk costs are really just a way to convince yourself to throw good money after bad.

But a caveat is that, housing prices generally do rise, so depending on how long you're willing to stay in your house, the market may rebound and your home value will rise back again. So cutting your losses early to save money may backfire if prices rebound. Of course investing in the stock market carries the exact same risks, so make an informed decision

Gevlon said...

The section suggesting to get a loan before defaulting is removed since found to be wrong. The new statement is "However it's only yours [your credit report devastated], your girlfriend or parents can still get a loan (with their good credit) and you can live there."

@Anonymous questioning the source: I'm sure that the national averages, home prices by state and such data are correct. The rest is simple logic and legal information which is subject to vary by state, therefore under "consult a lawyer" anyway.

@Gold NoScript: your claim that a $200K building worth more than $200K just because it's your home is nonsense. You can make a home in any appropriate building. Just remember, once the home of your parents was "your home", yet you left it and now you still have a home.

Neither it's true that you have to downgrade your home, even if the debt collectors keep pursuing you making you unable to get new loan. You can simply rent a similar, or even better home for less than you pay now for interest + underwater part of the principal (that's going down the sink anyway)

Gevlon said...

@csdx: about home prices going up again: you just made my next Monday Post.

Anonymous said...

@Gold No Scripts

"Everyone assumes bad credit falls off your report in 7-10 years, this is also not true as banks sell to collection agencys who sell to collection agencys until one collection agency finally gets paid. Each new collection account on your report starts that 7-10 year timer over. You will never get a mortgage ever with a 110k collection account on your report."

If you are in the US, this is untrue. The only thing that will start the clock running again on how long something can be reported is making a payment. The FCRA protects consumers against exactly the kind of credit report abuse you describe. The date used for calculating when something is to drop off of your credit is the date of last activity for the original account. If a collector is assigning new account numbers and changing dates in order to make it look more recent they are violating the FCRA, you can demand they remove the tradeline off your credit, if they don't you sue them...profit. Another fun thing, in the US, once an unsecured debt(as this is since you don't have the home anymore) goes to 3rd party collectors then you are also protected by another piece of legislation known as the FDCPA. The FCRA and FDCPA are their to protect the consumer. You don't have to fall into a cycle of bad credit like you suggest, you just have to know the law and challenge the bottom feeding collector's(in court if necessary).

Anonymous said...

While I understand the "business aspect" of the post, I think it's unfair to isolate the event as only affecting the individual. We're all angry at the banks and the ststem that alowed the excess lending, but when the Government has to "bail out" lenders and homeowners, we all pay somehow.

Maybe it's in higher taxes, more difficult terms on our own loans, a weakening of our currency, or whatever. But to think you can walk away and it only "screws the banks that made the loan" is unrealistic. All the US citizens were affected by this. In this case, the weak have brought down the rich. The sinking tide lowered all the boats.

Holger said...

@ csdx: no, cutting the loss now is better as taking the numbers of the original post:

you have 310k loan to pay.
you drop it and buy a new house for 200k (essentially your own house again, as this is it's new market value)
so you essentially loose 90k (what you already paid, no other money involved from your side, so 90k for nothing as you loose the house).

you buy a new house for 200k, same house essentially though.
So you get "your house" for 290k instead of 400k.

now for your "prices rising again":
both houses may eventually rise in value again, say the initial 400k.
This means you bought a 400k house for 290k.
instead a 400k house for 400k.

Anonymous said...

First, a note on language: the idiom you want is "give them the finger" not "a finger". It's the difference in flipping them the bird (middle finger extended) and, I don't know, chopping one off as a gift?

While you make a reasonable point regarding walking away from an underwater loan, I think you overlook some important effects of that choice. This article (http://meganmcardle.theatlantic.com/archives/2009/12/personal_finance_1.php) captured what I think is a true understanding of the unintended consequences of your recommended practice. But I would be interested in your response, if you disagree.

Spinks said...

@gold noscripts:
"Let's not forget that walking away means loosing your HOME. I personally value my home more then I value a piece of property."

That's the main reason that a lot of people don't walk away when perhaps it might be a better option for them. Esp if they are young and have time to rebuild that credit rating.

You can get another home. There's nothing wrong with renting.

Ian said...

"All the US citizens were affected by this. In this case, the weak have brought down the rich. The sinking tide lowered all the boats."

I don't know what version of events you have seen, but it has been my observation that the weak have had their now-and-future taxes promised to the rich in order to make sure the rich don't lose any money. Most recently, Fannie and Freddie Mac were both promised unlimited access to bailout funds, and the SEC changed regulations so that money market accounts may be frozen at any time (ie: if the account manager says so, you can't take money out of your account, indefinitely). If those aren't both examples of the wealthy finance industry overlords continuing to crap on us all, I don't know what is! And that's just in the last week, things like that have been going on all year while the taxpayers are all promised that "everyone is suffering." It's a crock of lies, Fannie and Freddie's CEOs are both making over $6 million a year despite the estimate that together they are on the hook for a lost $500 billion - which you and I are now on the hook for.

Eaten by a Grue said...

Gevlon,

I am a little disappointed. I always took you for someone who valued individual responsibility but would respect the property rights of others. It seems, in your last response to me, that really the only thing keeping you from becoming a criminal is fear of the law. I thought you were better than that.

Also, even from a selfish perspective, proposing that it is OK to steal really just screws up the society that you have to live in. If everyone behaved like you, you would be much worse off, so perhaps you are better served by keeping your borderline sociopathic theories to yourself rather than making converts.

Anonymous said...

I know you were basically using Home mortages as an example and would expect before anyone walk away from a debt that they understand all the ramincations of doing so - the main point is though it should be kept as a vialble option.

I would also like to point out that all of the US housing market has not gone in the tank. If you live in Florida or California and some of the cities hit very hard by the recission sure but there are a lot of places that are doing very well. In the last 3 years I have sold and bought 2 houses. One in Houston and the other in Birmingham (Alabama). Both markets were/are very staable.

Enjoy the blog (I know you don't care.)

jj

Anonymous said...

Walking away does not seem nearly as good a move as talking to a mortgage modification lawyer and getting your balance reduced to reflect the price of the property. There are actually government programs available right now that allow for this. Why buy a new 200K home for 200K, when you could get your 300K mortgage reduced to 200K without killing your credit rating in the process?

csdx said...

@Holger
ahh, but not all houses are created equal, while one area may rise, the next neighborhood over may fall to crap. Also you're unlikely to be able to get a new loan at good terms, funny how credit rating works like that.

My point was made with the implication that you wouldn't be able to pick up another house at least for awhile, so it was more akin to just selling an asset at a loss without being able to reinvest in it. So thus depending on how you though real estate would move and your timeframe, the choice could be different.

But you're right, if you are able to drop any asset and only realize part of the loss, picking it back up again is profitable. However, financial institutions are set up to generally not allow you to do that.

csdx said...

@Eaten by a Grue
how is it stealing? The mortgage contract clearly stipulates what happens in the event of a default: you lose your collateral (house). Basically you're choosing whether you're losing the house or the

Is it stealing to return merchandise to a store and ask for a refund (say the object just dropped to 1/2 price)? The store has to take the loss in the difference since they can at best sell for the new price only.

Is this any worse than getting out of a cell phone contract early and paying the termination fee?

Anonymous said...

lol. Only those that can afford a lawyer can walk away. And even then it takes 7 years to erase that off your record. Lenders relaxed it to 2 years during the housing boom, but it is now back to seven years. Yes you can walk away, but there is a huge price. In the realm of real estate it means you will not be able to purchase a home without a co-signer. Land lords and Employers also look at your credit rating, and they may chose not to allow you to stay or be hired because of it.

For many people walking away is not an option.

Anonymous said...

@Ian:

The Fannie Mae and Freddie Mac CEOs are not 'the rich.' They're a handful of CEOs. The people who will be paying for those buyouts are those who make money and get taxed-- essentially, every non-m&s person in America for the next few decades. Including, I hope, yourself. If you want to amass any kind of wealth at all, you're going to have to bear that weight.

Your definition of 'the rich' makes you sound like an idiot. There's a difference between 'the rich' and 'a narrow band of the extraordinarily wealthy who hold unique employment positions'. Given our tax system, the rich will continue to pay for the incompetencies of the m&s.

Eaten by a Grue said...

@csdx

I am aware that breaching a mortgage agreement is not the same as stealing and is an acceptable action in some situations. I was responding to what Gevlon wrote in his response to my first posting.

MuShU said...

Loved the article! A few points:
1. walking away is not the end of the world even though you have been lead to think it is. I have done so (divorce) and left a home and car and all my debts. Yes it was on my credit report but after about five or six years of *perfect* bill payment history no one cared anymore. Six years is nothing in the timeline of your life.

2. a home is only a *thing* and has no value other than that assigned by buyers. Since my bankruptcy I have rented and put a lot into savings. No one has convinced me that owning makes financial sense. I pay, say, $1k per month with ZERO other responsibilities. The landlord has to repair and upgrade everything. Yes I lose about $12k per year but that is equal in my mind as a barter to live where I want to and have the freedom to up and leave with a 30 day notice! I like my freedom and flexibility to live life under MY terms and not be locked down to a certain geographic location.

3. You CAN easily survive a bankruptcy. My credit score is now a few points under 800 and I still make *every* payment to *every* debtor ontime. I am the kind of customer *any* business wants. :)


@Ian: You sound just like a liberal, spouting that nonsense. It is a documented fact (go ahead, look it up, I dare you) that the government (yes, under Bush, and amazingly again recently under Obama) FORCED the lending/banking industry to open up and perform more loans to minorities and other *under-represented* segments of society in America AGAINST common business sense! They were threatened with sanctions and tax increases if they did not meet a minimum number of loans to people who did not qualify under current banking norms for a home loan. THAT is precisly the reason why the loan industry failed, and to blame the bankers/lenders is simply ridiculous! Again, this is fact, regardless of whether you want to believe it or not.

@GoldNoscript: Wow, you're so wrong I don't know where to begin. A discharge of debt is just that: a discharge. I've been through it myself, have you? You really work in the industry?!? pffft...

TheCalifornian said...

Just wanted to concur with Euripides, above; I often dislike your philosophy posts, but this one was quite good. As were you two recent WoW posts. Thanks for the read.

TheCalifornian said...

@MuShU: Did the government also force the banks to leverage such obviously bad loans 30x? And force the rating agencies to give the securities triple A's?

Those poor banks, they didn't *want* to loan to the bad brown people. The guv'memt made 'em do it.

Mark said...

New York Times Mag ran a column on this topic by Roger Lowenstein, an outside director of the Sequoia Fund. He quotes a U. of Arizona professor who argues that "the government should stop perpetuating default 'scare stories' and, indeed, should encourage borrowers to default when it’s in their economic interest. This would correct a prevailing imbalance: homeowners operate under moral constraints while lenders are busily trying to maximize profits".

If the scales were balanced, he argues -- that is, if homeowners acted as cold-blooded (and rational) as lenders do, then banks might become more amenable to modifying loans for homeowners, because there's the very real threat they'd walk away.

Story's here: http://www.nytimes.com/2010/01/10/magazine/10FOB-wwln-t.html

7johnsons7 said...

I have been living in my home for 11 years. My husband and I planned to raise our 6 kids here in this picture perfect neighborhood, a small house surrounded by mc mansions. Seems he tired of the plan about 3 years ago and discarded the baggage of a family neighborhood and house full of teenagers (complete with all their teenage angst). This was after we had taken out a huge second mortgage to spend on his education. So when we divorced I used my half of the 401K to buy down the mortgages and refinance. I was so proud of qualifying for a $250K mortgage on my salary alone. This is where the pride aspect of keeping the house comes into play. My education is limited to the 8th grade and a GED, and I worked my butt off to get to a point that I could be proud of being a homeowner after a traumatic childhood. I wanted to give my children the american dream, always knowing they had a place to come "home" to. But now that the crash has continued, my house is literally 100% underwater. I had paid $60K to bring it from $310K to $250K, and now houses on my street that are larger and more updated are selling for $120K. Technically, nothing has changed from when I signed my loan. I earn the same money, and the payment is the same amount. That is where my moral obligation comes into play. How can I justify walking away from a promise I made when I signed the document, if I can still afford to make the payments? What has changed, is that my children got older, and their troubles are tied to their relationships with thier friends. The two teen boys still at home are constantly in trouble for using marijuana and have been suspended several times. One is now being drug by the county. The amount of time I spend in meetings with the school, court, probation officers, and community service, is seriously jeopardizing my job. This is a valid reason to move. Moving is what a responsible parent is supposed to do. But I am chained to my mortgage, and now I must decide between what is right for my children, and what is right in my perception of what the world will think of me for "walking away". In a normal economy, people buy and sell all the time, changing their living arrangements to suit the lifestyle of the occupants as their needs change. How many people out there are in the same situation I am? House is now too big, or too small for the people left living at home? Is the new job farther away and moving closer a prudent solution? Is keeping up with the maintenance still possible without a handyman in the house? (repairs that would have been done by my spouse are running about $5K per year). I have been doing the math to an insane degree, calculating the income tax benefit of keeping the mortgage balanced against rent for a similar property. The interest consequenses possible with my credit cards. The commuting costs (my new job is 40 miles each way), the cost of repairs, maintenance on the pool I never use, and coming to a figure that I can compare with area rents. Then there is the consideration that owning means you can do what ever you want in your home. I own a rottweiler, I love exotic lighting and bold paint colors, I'm very picky about plumbing fixtures, these are all choices I can make because I own. As a renter, someone else will decide these things for me. So now we can add the idea of "Independance" to the list of reasons a person decides not to walk away when they are underwater.