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Every where you turn there’s a new mortgage program out there for people unable to afford their mortgage for a variety of reasons.  Homeowners are spread thin, often a mile wide and an inch deep when trying to cover all of the costs associated with paying a mortgage and owning a home.  These include:

  • Mortgage
  • Home owner’s Insurance
  • Property Taxes
  • Utilities
  • HOA fees
  • Maintenance fees
  • Condo fees

So what happens when after paying all of the above-mentioned fees the value of your home tanks to 50% of what you paid for it?  Should you continue paying into an investment that is essentially worthless?  Or should you be able to give it back to the bank in exchange for being released from the loan while taking a hit on your credit report?  What if you can afford the payments but you don’t feel that the investment is worth it to continue making payments?

Hard Questions Invariably Bring Hard Answers

This is the other side of the debate that no one really talks about. The homeowners who can afford the home, but plan to strategically default due to the declining value since the beginning of the recession.

The New Yorker published a piece, Living By Default  by which ever so neatly delved into this issue: (skim the bold font for a quicker read)

“It is now generally accepted that when it’s economically irrational for a company to keep paying its debts it will try to renegotiate them or, failing that, default. For creditors, that’s just the price of business. But when it comes to another set of borrowers the norms are very different. The bursting of the housing bubble has left millions of homeowners across the country owing more than their homes are worth. In some areas, well over half of mortgages are underwater, many so deeply that people owe forty or fifty per cent more than the value of their homes.

In other words, a good percentage of Americans are in much the same position as American Airlines: they can still pay their debts, but doing so is like setting a pile of money on fire every month.These people have no hope of ever making a return on their investment in their homes. So for many of them the rational solution would be a “strategic default”—walking away from the mortgage and letting the bank take the house. Yet the vast majority of underwater borrowers keep faithfully paying their mortgages; studies suggest that perhaps only a quarter of all foreclosures are strategic. Given how much housing prices have fallen, the question is why more people aren’t just walking away.

Paying your debts is, as a rule, a good thing. But the double standard here is obvious and offensive. Homeowners are getting lambasted for doing what companies do on a regular basis. Walking away from real-estate obligations in particular is common in the corporate world, and real-estate developers are notorious for abandoning properties that no longer make economic sense. Sometimes the hypocrisy is staggering: last winter, the Mortgage Bankers Association—the very body whose president attacked defaulters for betraying their families and their communities—got its creditors to let it do a short sale of its headquarters, dumping it for thirty-four million dollars less than the value of the building’s mortgage.

When it comes to debt, then, the corporate attitude is do as I say, not as I do. And, while homeowners are cautioned to think of more than the bottom line, banks, naturally, have done business in coldly rational terms. They could have helped keep people in their homes by writing down mortgages (the equivalent of the restructuring that American Airlines’ debt holders will now be confronting)

So far, banks have been partially insulated from the consequences of those bad decisions, because Americans have been so obliging about paying off overinflated mortgages. Strategic defaults would help distribute the pain more evenly and, if they became more common, would force lenders to be more responsible in the future. It’s also possible that a wave of strategic defaults—a De-Occupy Your House movement—would get banks to take mortgage modification more seriously, which would be all for the better. The truth is that banks have been relying on homeowners to do the right thing. It might be time for homeowners to do the smart thing instead. 

What would a great argument be without opposing, yet valid viewpoints? 

Obviously there are two sides to this debate:  Strategic homeowners who see this as a business decision vs homeowners who feel a moral obligation to continue throwing good money after bad money.   Who wins?  Who is right given the above-mentioned factors?

Felix Salmon from Reuters.com poses an interesting counterpoint to the New Yorker’s assertion that more homeowners should strategically default in order to level the playing field:

“I agree wholeheartedly with Jim Surowiecki’s sentiments this week about strategic default and the way in which it’s entirely rational for homeowners to walk away from their underwater mortgages. But I think he soft-pedals the consequences of what he calls “a De-Occupy Your House movement”

I’m not convinced that a world where homeowners mark their homes to market is an obvious improvement on the status quo ante — even though I’m wholly convinced that in any given case, it’s entirely rational for homeowners to walk away from their underwater houses. The question, of course, is whether we can ever return to the status quo ante.

Let’s say that you’re significantly underwater on your mortgage and you don’t have much in the way of savings. Does it then make sense to say that you’re insolvent? Historically, homeowners never thought that way — the mortgage was a monthly payment they made to stay in their home, and their home was a place to live rather than a financial asset.

If we move to a world where houses do become financial assets, that might be a good thing. But let’s be honest about what such a move entails: a large decrease in home ownership. It’s not sensible, on a financial level, to have so much of your net worth tied up in one illiquid asset. So if homes are marked to market, they become attractive mainly to landlords who will in turn rent them out to the rest of us.

If Surowiecki wants millions of Americans to walk away from their underwater mortgages, I hope he knows where the buyers of those homes are going to be found. Because if they don’t appear, we could have another massive housing crash and another huge recession.”

 

Richard Barrington then chimes in with the unintended consequences of the “De-Occupy Your Home” movement described by the New Yorker:

To really understand the unintended consequences of the Occupy Our Homes movement, you have to think of the people on the other side of the issue. After all, it’s not just banks that are hurt when people fail to meet mortgage obligations. Other victims could include:

  1. Future mortgage borrowers. Especially at current mortgage rates, banks have little enough incentive to make new loans these days. If they are blocked from collecting on their loans, future borrowers can expect mortgages to be more expensive and/or harder to obtain.
  2. Current homeowners. For the same reason as the above, the actions of Occupy Our Homes may make it tougher for current homeowners to refinance their homes. Ironically, the more homeowners can take advantage of current mortgage rates, the fewer would have to face foreclosure.
  3. Depositors. Low interest rates on savings accounts and other deposits are partly the result of weak profits in the lending business. Erode those profits even more, and you can forget about seeing those interest rates rise anytime soon.
  4. Bank shareholders. No, don’t think about rich one-percenters. More likely, bank shareholders are pensions and 401k plans, whose participants are ordinary people. When borrowers don’t meet loan obligations, those ordinary shareholders can take the hit.

In short, the Occupy Our Homes movement seems to demonstrate that good intentions don’t always make for a good cause.

 

All three are very rich and valid perspectives which make for a hearty debate around whether or not one should strategically default on their credit obligations in the face of declining asset values. Homeowners today face tough decisions that draw on morality which breeds a sense of obligation.  All while making a decision that could have deep consequences for their financial future.

What say you?  Should homeowners walk away and level the playing field?  Should residential real estate be seen simply as the place you live in and not as a financial asset?  Or should we fear the consequences of the De-Occupy Your Home movement and stay put?  Let’s discuss!

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