Walking away from a mortgage

From the beginning of the mortgage crisis Mish Shedlock has been writing clear-eyed posts on the matter of walking away from a mortgage. He has repeatedly emphasized that the ethical issues involved in walking away do not extend beyond the terms of the contract—and all such contracts recognize the possibility of default and spell out the procedures for dealing with it. Meaning that default is not an ethical lapse, no matter how much the lender might try to persuade you otherwise.

Yesterday Mish added two more posts on the topic. The first discusses how shame and fear have been explicitly adopted by the government and by lenders as tools to manage the crisis:

Government, lenders, and various lender-sponsored "help" agencies have acted in unison, using fear mongering tactics and shame to manage the housing crisis for the sole benefit of lenders.

Thanks to Brent T. White at the James E. Rogers College of Law and the Sacramento Bee and for a fascinating called Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis.

Note: The PDF is 54 pages long and worth reading in entirety but I have condensed the discussion down to a very readable 3-4 pages of so.

Mish’s summary of the report is long and detailed, but worth reading.

In response to this post, Mish received an email from a mortgage consultant that not only confirms the truth of the above-mentioned report, but it explains how reality contrasts with most people’s baseless fears.

I wanted to let you know that I deeply appreciate your post on strategic defaults. I get people calling me all of the time looking to refinance and when I find out how underwater they are I tell them it might be wise to walk away from the property.

I also tell them the consequences of walking away. Like the article said, a foreclosure will stay on your credit report for 10 years. However, if you walk away it will only be 3 years before you can buy a home again. (It used to be 2 years but Fannie, Freddie, and the FHA made it longer to discourage people from walking away.)

I tell them if they choose to walk away they need to make sure they have a decent car, and at least one credit card. The reason for the car is that it may be hard to get a decent rate on a car loan for a while if they have a recent foreclosure, and the credit card is needed to help you re-establish your credit after the foreclosure. One of the biggest mistakes people make after a bankruptcy or foreclosure is not re-establishing their credit.

I do believe that in the future the guidelines will be changed to allow people who have re-established their credit to purchase a home 2 years after a foreclosure. This because there will be thousands such potential borrowers and it would be stupid to prevent them from re-entering the market.

The other night I meet some friends for dinner. When a got there a lady I used to work with came up to me and told me her situation. In 2007 she bought a condo in Arlington, Va. for $300,000 and its value had dropped to $200,000. She still owed $295,000 on it. She told me she could afford the payment, but was considering walking away. I asked her what was her mortgage payment and condo fees were. It came to $2,300/month. Then I asked how much would it cost to rent a similar apartment. Her answer was $1,200-1,300.

I said the answer was easy, walk away. In fact, I told her I would stop paying the mortgage and see how long it took them to foreclose. She might be able to live there 6 months or more rent free.

Her fiancé was there and he didn’t agree with my answer. He said that her credit would be ruined for ten years and that the value would come back. I responded that a foreclosure would stay on a credit report for 10 years, but if you work hard at re-establishing your credit, the score can come back in a year or two.

I have seen people plenty of people with credit scores over 700 within one year of a bankruptcy or foreclosure. As far as the value coming back, I told him that it would take 10 years or more before that value comes back.

More people need to know that foreclosure is not the end of the world and that their credit can come back in a couple of years or sooner, especially if they take the right steps prior to the foreclosure.

The mortgage crisis does raise many ethical issues, but I think they involve our ability and willingness to enter into such contracts in the first place, not in how they are executed.

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7 thoughts on “Walking away from a mortgage

  1. The abstract of that report says this:

    Norms governing homeowner behavior stand in sharp contrast to norms governing lenders, who seek to maximize profits or minimize losses irrespective of concerns of morality or social responsibility. This norm asymmetry leads to distributional inequalities in which individual homeowners shoulder a disproportionate burden from the housing collapse.

    Some connected but disorganized thoughts and questions:

    *Not every unequal relationship is unethical or unjust. The parent/child relationship for instance.

    *Scripture says the borrower is slave to the lender. This is obviously an unequal relationship, but, since not all slavery is immoral, is it unethical?

    *I seem to remember that Paul says somewhere (though I can’t find it now) that if a slave has an opportunity to gain his freedom he sould take it.

    *How do we determine if the inequality mentioned in the quote above is unjust/immoral?

    *If the modern situation really is unjust, then not only should people not be made to feel immoral for getting out of it, but they should be encouraged not to enter into that kind of a relationship in the first place.

    *If it really is unjust, then are we borrowers at fault for attempting to profit from it? I’m thinking of our situation — we’re finally right-side-up on our mortgage here in VA, but we’re hoping that the market will come up enough in the next year or two that we’ll be able to afford to sell it for more than we owe and use the extra to build a more suitable house on our Missouri property.

    *I almost wish I had a crystal ball. Our real estate agent friend told us recently that a whole slew of foreclosed houses in our area are going to flood the market in the spring. *sigh*

  2. Mish’s ethical reasoning is not an uncommon sort of ethical reasoning, but it’s not a set of ethics you would share. I’m assuming that you’re finding the conclusion to be one that you can possibly see justifying from your own point of view, and not buying into his ego-centric utilitarianism (or whatever it is, it seems to be a muddle of rationalizations). Setting aside his reasoning, I’d like to hear more about your own.

    Every legal contract specifies, explicitly or implicitly, the penalties and consequences for non-compliance. Is there a general principle that could be put into words to explain why walking away from this kind of contract could be ethically okay? In particular I’m wondering how general the principle actually is. Does it apply to every sort of contract or agreement one might enter into? And, generally speaking, is the consideration only what the other party to the contract is very likely to settle for, rather than what they are legally entitled to in theory (as in the case of mortgages, in some states)? Does this sort of reasoning only apply to legal contracts, or does it apply to “giving ones word” in other contexts? Or even more generally, to other laws and social norms, where one can know with reasonable confidence what the consequences would be? Perhaps only where one can convince oneself (as Mish does in this case) that the other party has been overly greedy or unwise or something and therefore doesn’t “deserve” to get what the law says they are legally entitled to, and when, in practice, they can’t actually collect on it without the borrower’s cooperation (which Mish points out is not the case for mortgages in Florida)?

    Why, for example, wouldn’t a parallel argument apply to paying taxes. In practice (as with walking away from a mortgage) there are all kinds of ways one could hold back some money from the government that one is legally obligated to pay, and have very high confidence that the actual consequences would be zero, or at least very low and certainly not involving anything but a financial penalty. Mish points out (not in the structure of his main argument, but more as an aside) that lenders have arguably not taken fulfilled their own ethical obligations in some sense. Certainly some people would say the same about the US government. So is there a parallel ethical argument for deliberate underpayment of taxes?

    And the same sort of reasoning could apply to employment contracts, car loans, etc. I don’t know (or much care) how Mish stops from going down that slope, but I’d be interested in your own thoughts.

    (If it matters, my opinion of Mish is shaped by some of the links on his page, some of which I think are questionable and exploitive. But taking his argument about mortgages at face value, it’s really more of an argument about “what you can get away with” than an argument about what’s ethical. The ethical part seems tacked on as more of an afterthought.)

  3. dj,

    I think you are misreading Mish. I don’t know of anyplace where he suggests that a mortgage holder should even bend the law, much less break it. He is merely pointing out that a mortgage contract clearly specifies what happens where the borrower defaults, i.e. stops paying on the loan. And that a mortgage holder is not ethically obliged to do anything beyond abiding by those terms.

    I suppose some borrowers might see their mortgage as constituting something beyond the actual legal terms spelled out in it, as some sort of promise to pay under any but the most dire circumstances. And it is certainly to the advantage of the lender for a borrower to see it that way. But that shouldn’t bind the conscience of anyone who sees a mortgage as the limited, specific legal contract that it is.

  4. I was probably wrong to say that the mortgage contract specifies what happens when a borrower defaults; that is probably spelled out by some state law. My point, though, is that the possible outcomes are fully understood and agreed to by both parties before the contract is agreed to.

    In California, a non-recourse state, the lender knows in advance that if a borrower defaults, they are entitled to the house and nothing more. And the borrower knows that, if they default, they will lose the house and take some sort of hit on their credit report. That is part of the agreement. The agreement does not include a promise from the borrower not to default, or to only default in extreme circumstances, or anything like that.

  5. I get stuck on the idea of looking at an enumeration of actions and consequences, and reading into that an ethical standard. Certainly you can calculate the “rational self-interest” course of action that way, and if someone defines their ethical standard that way then I guess they’re done.

    In the case of a mortgage, isn’t there at least an implicit promise to make a good faith effort to pay back what you borrowed and the agreed-upon interest? It’s not something you can define in legalese but that doesn’t mean it’s not part of what it means to enter into an agreement.

    Similarly with an employment contract. On one level, there’s nothing that says someone can’t decide that today would be a good day to go to Tahiti, dump their work on their boss’s desk and walk out the door forever. The legal consequences may be spelled out (in practice it’s probably only cause for immediate termination and with a large company you’d still get your final paycheck, if grudgingly). And of course it hurts your reputation if you ever want to work in the same industry and you wouldn’t want to use that boss as a reference. But wouldn’t the action/consequence calculus from the mortgage case apply here to let someone conclude that such an action is ethical?

    That’s where I’d disagree with the reasoning. Even if it’s not spelled out, there’s an implicit understanding that when you hire someone, they’re going to make a good faith effort to do the job (one hopes). Imagine how the contract would have to be written to enforce such an assumption.

    Or maybe even more clear an example, is it unethical to imitate Wally from Dilbert, and draw a paycheck while trying to do zero work for as long as possible? The consequences are clear: in most non-government jobs you’d be out quickly, or at least after a bad review or two. Under the contract the consequences are clear (termination for cause, maybe a bad reference but often not even that because companies don’t want to risk being sued). I don’t remember any employment contract that spelled out that I had to “work hard” or anything of the sort. The employer and I both understood when they hired me what the consequences would be if I chose not to do the work I was expected to do.

    And yet that action/consequence calculus and the explicit terms of the employment contract seem to me to miss the whole point of whether such an action would be ethical.

    Sorry to meander so much. If I had more time I probably could have said all of the above in one paragraph.

  6. dj,

    In the case of a mortgage, isn’t there at least an implicit promise to make a good faith effort to pay back what you borrowed and the agreed-upon interest?

    I think we need to distinguish between moral obligation and legal obligation. A contract is what we resort to when a promise won’t work, e.g. when we want to enter into an agreement with someone outside our community who isn’t bound by its moral rules and sanctions. It’s not a very good substitute; as you point out, there’s really no way to use legalese to capture the essence of what a promise is. But we still need one in situations when a promise isn’t truly binding—when dealing with outsiders, or with fictional persons like corporations who are not members of any moral community.

    Maybe a less loaded example is a driver’s license. I have one, and I think it’s fair to say that it includes an agreement to abide by the rules of the road. Now, I don’t always abide by the rules of the road. But the only time I feel bad about it is when I’ve done something unsafe, endangering myself or others. I’ve gotten a few speeding tickets, but never in a situation where my speed was unsafe. I accept that in those cases I had violated my obligation to abide by the laws of the road, but I don’t think that what I did was morally wrong. On the other hand, I have occasionally done something dumb or reckless while driving, none of which I was ticketed for, all of which I was ashamed of.

  7. Did my employment contract example strike you as a loaded example? Certainly not intended that way but I’d be curious as to why it might have seemed so. It seems to me to be a close parallel to the mortgage example, except one in which I think we’d both agree that there is an implicit promise that goes beyond the explicit terms of the contract. And that would be my inclination if I had a mortgage I couldn’t pay, to view it as having given my word in a way that’s binding beyond the literal terms of the contract.

    A contract to pay for a car in installments seems like another example that is largely parallel, but doesn’t fit with the “walk away” argument for mortgages.

    All of these, including the mortgage example, seem a lot clearer if we imagine that the deal is made more directly with an individual rather than with a corporation. Imagine buying a home with a mortgage via owner financing, rather than a bank mortgage. The terms could be entirely the same, but now there’s a person waiting for that check each month. Or an employment contract in a small company, in which you work directly for and with the owner of the company. Or a bank mortgage, with a small local bank instead of some mega corporation.

    But that just reinforces my intuition about the conclusion. I can’t see making a distinction between giving my word to an individual, and giving my word in some transaction with a corporation. It’s too much like the common rationalization of various kind of theft or whatever “not really hurting anyone” because it’s theft from a large corporation that is spread out over so many individuals that none are measurably hurt. (Didn’t you recommend the movie, The Ladykillers? There’s a line along those lines in there I think.)

    I agree with your conclusions about the driver’s license example, although it feels (for my own thinking about my own speeding) more like a rationalization. But walking out on a mortgage, or discontinuing payments on a car, or abruptly quitting a job when people are depending on you and will have an extra burden of taking over your work until a replacement is found, are actions that have a negative effect on other people. The more people who do those things, the more tangible the pain caused to other people. Large numbers of “strategic walkouts” would have large consequences for a lot of people, and not just people on the other side of those mortgage transactions.

    Speeding is justifiable (or rationalizable) in a different way when it’s genuinely safe, because if it’s genuinely safe then there’s no harm to anyone.

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