Walking away: a trip down the rabbit hole

The Wall Street Journal takes a look at a California neighborhood where “strategic default,” i.e. walking away from a mortgage one can still afford the payments on, and comes up with a couple of examples guaranteed to raise the blood pressure of folks who suspect that there is something unethical about it all.

Schoolteacher Shana Richey misses the playroom she decorated with Glamour Girl decals for her daughters. Fireman Jay Fernandez misses the custom putting green he installed in his backyard. But ever since they quit paying their mortgages and walked away from their homes, they’ve discovered that giving up on the American dream has its benefits.

Both now live on the 3100 block of Club Rancho Drive in Palmdale, where a terrible housing market lets them rent luxurious homes — one with a pool for the kids, the other with a golf-course view — for a fraction of their former monthly payments.

The housing bust has brought big changes to the 3100 block of Club Rancho Drive in Palmdale, Calif. See details on the homes, debts and residents. "It’s just a better life. It really is," says Ms. Richey. Before defaulting on her mortgage, she owed about $230,000 more than the home was worth.

It gets worse.

Some are leaving behind their homes and mortgages right away, while others are simply halting payments until the bank kicks them out. That’s freeing up cash to use in other ways.

Ms. Richey’s family of five used some of the money to buy season tickets to Disneyland, and plans to take a Carnival cruise to Mexico in March. Mr. Fernandez takes his girlfriend out to dinner more frequently. "We’re saving lots of money," Ms. Richey says.

The beginning of the story is common enough:

Ms. Richey, the teacher, arrived in Palmdale in 1999. In 2004, she and her husband, Timothy, bought a two-story home on Caspian Drive, near Avenue O-8, with a no-down-payment loan. They took pride in the amenities they installed: a powder room with granite countertops, a backyard pool and play area, and the purple-and-turquoise fantasy playroom upstairs for their three daughters. But the value of the house plunged to less than $200,000 in 2009. Their $430,000 mortgage, with its $3,700 monthly payment, began to look more like an unwanted burden.

Attempting to solve the problem, the Richeys first turned to their bank:

By May, amid troubles getting tenants for two rental properties she also owned, Ms. Richey decided the time had come to cut a deal with America’s Servicing Co., a unit of Wells Fargo & Co. servicing the mortgage on the house. After three months of wrangling, she says she finally received a modification approval. The new monthly payment: about $3,300, far more than she had hoped. A Wells Fargo spokesman confirmed the bank offered Ms. Richey a modification under the Obama administration’s Making Home Affordable program, and said, "The Richeys turned down the lowest payment we could offer."

Not able to reach an agreement with the bank, they turned to strategic default:

Ms. Richey and her husband had already been working on Plan B—exploring the neighborhood’s "For Rent" signs. On one trip, they drove by the house at 3152 Club Rancho Drive. It was bigger than their house on Caspian, had a pool with three waterfalls, and boasted a cascading staircase that Ms. Richey says she could picture her daughters descending on prom night. The rent was $2,195 a month.

The situation presented Ms. Richey with a quandary now facing more than 10 million U.S. homeowners who owe more on their mortgages than their houses are worth. On one hand, walking away from her home would be easy. California is one of 10 states that largely prevent mortgage lenders from going after the other assets of borrowers who default. But she also had to consider the negatives. Her credit could be tarnished for years and, perhaps most importantly, she feared her friends and neighbors might ostracize her.

The Richeys conquered their qualms and went ahead with the default. The benefits were immediate:

Ms. Richey and her family made the move to Club Rancho Drive in August, when she was already several months behind on the mortgage. With Mr. Robbins’s help, she recently sold the house on Caspian Drive for $195,000, money that the bank will accept to settle the $430,000 mortgage debt. She’s also considering walking away from the mortgages on her two rental properties.

Showing a visitor the personal touches in her new home, including a $1,800 dining set she bought with some of her newly available income, she notes the advantages of being a renter rather than an owner. "You take a risk for the American dream," she says. "I don’t have to worry about paying property tax, homeowners’ insurance, the landscaping, cleaning the pool or any repairs."

A neighbor has had a similar experience:

Others on Ms. Richey’s block have made similar moves. Mr. Fernandez, the firefighter, moved into 3139 in July, after stopping the $4,800 monthly payments on the home he owned around the corner on Champion Way.

Mr. Fernandez says he made four attempts to modify the larger of the two mortgages on his home, which add up to $423,000. Ultimately, he was offered a monthly payment that, together with back taxes, was higher than what he had been paying. Today he’s working to partially reimburse his lenders, IndyMac Bank (now OneWest Bank) and American First Credit Union, by selling the home, which he expects to fetch about $300,000. […]

With an income of about $8,300 a month and a rent of $2,200, Mr. Fernandez says he now has the wherewithal to do things he couldn’t when he was stretching to pay the mortgage. He recently went to concerts by Rob Thomas and Mat Kearney. He also kept his black BMW 6 Series coupe, which has payments of about $700 a month.

The irony is that the rents being paid by the Richeys and Mr. Fernandez would have been about the same as what the new owners will pay on their defaulted houses.

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18 thoughts on “Walking away: a trip down the rabbit hole

  1. Rick –

    Putting aside their bad indulgent behavior after the fact, I’m curious what you think is the right thing to do when you owe $430,000 on a house now valued at $200,000 as described in this piece? Or perhaps where you’ve been out of work and take a job with substantially reduced income that makes the mortgage now untenable. Your thoughts? Thanks.

  2. Just a quick thought in response to the above comment…

    I’m not sure it is appropriate to “put aside their bad indulgent behavior.” The right thing often has to do more with the attitudes and desires of the hearts than it does with the outward behavior. The process of default/foreclosure was established as a form of mercy to be extended to those who found themselves in need. When people begin to take advantage of these forms of mercy for the sake of their own personal gain, this is exactly the core of the issue.

    When one takes out a loan for a piece of property, they agree to repay THE LOAN. There is nothing in the contract which says that the loan should be adjusted if the estimated value of the house changes. I do not see people clamoring for higher loan payments when their houses go up in value. The loan, however, does have an “out” for folks in actual need.

    I know that not every single situation is cut and dry–especially when dealing with an out-of-work situation where one can pay now, but maybe not later, and will eat through their savings in the process. But so many, many folks out here and simply expressing hearts of greed and selfishness, and bankrupting locally owned banks in the process.

  3. Here’s something to think about — we bought this house a little over four years ago. It’s a 30 year mortage, and as of today we’ve paid back nearly half the original purchase price.

    Each year we’ve paid maybe one or two extra monthly payments, but honestly… in another three and a half or so years we’ll have repaid the entire purchase price of the house, but we’ll still owe for another twenty years.

    Seems to me that the banks are showing a fair amount of greed and selfishness, too.

  4. Kelly,

    On the one hand, I agree with you, in the sense that I am against usury in principle. Ideally, we would not have built a usurous culture. It does seem that usury cares a level of greed embedded in the system.

    I know what it is like to “need” to take out a loan to “own” a home. We know some folks who were saving to pay cash for a house, but we simply didn’t have the cash to save. All of our extra money was spent in paying rent. So we looked at buying a house via loan as renting-to-own, so to speak. Eventually, before we die, the house will be ours.

    However, on another level, I don’t think the banks are showing greed or selfishness, in the sense that we, when we took out a loan, signed up for exactly what we are getting. No one forced us to sign up for it.

    Within a usurous culture, I don’t know exactly where the high road is for those of us who are unable to save and pay cash. (Hopefully, Rick does. :) ) But I don’t know if I’d call it greedy for them to offer a loan and me to accept it.

    Sorry to hijack your comments, Rick…Half of my neighborhood has been foreclosured or defaulted on within the last six months, so it is something I spend a lot of time thinking about. I wonder what sort of neighborhood I will be living in in a year.

  5. Three years ago I asked myself that same question…

    We thought we had done the right thing by purchasing a home on the outskirts of Miami, FL, since in the more established areas homes were selling well over 400k. We purchased a preconstruction home for 250k, well within our means. Six months after we moved in, the market drastically changed and the small developer was left with an inventory of 15 homes. To our surprise the developer instead of reducing prices to sell off the inventory rented those homes to section 8. Just a few weeks after that we were broken into. I established a citizens crime watch and invited all the neighbors, homeowners and renters alike. That night we were informed that our break in was just one of 20 that had occurred in a four week period. The next day after our meeting, we were broken into a second time. We stayed in the community for another 6 months trying to do the right thing, but the community continued to deteriorate. We moved out a year after owning the house. It was a very difficult and emotional decision, we had so many expectations, but it came down to one simple decision, the house or my marriage. We rented it for two years at a monthly loss of $900 in addition to the 10% down and over 20k we had spent on upgrades. The house comparables are now $115,000.

    Granted, our experience is unique and our decision to ultimately default might be more morally justified than others. I do have an issue with the contractual obligations that were made in a market that had inflated appraisals, loose lending, pressure from Wall Street to package pools of mortgages for profits, bail outs that continue to help the very banks that created the securitization of loans, banks not willing to work out modifications in a reasonable and timely manner, the fact that most mortgages had PMI policies mulitiple times over their insured value for profits (this is why AIG got bailed out), bank auctions that are selling homes at a fraction of what the homeowners could’ve refinanced/repurchased them for…..

    Youtube: http://www.youtube.com/watch?v=MwU-d-RYYYg

    These reasons are sure to cause more underwater homeowners to strategically/rationally default, thus bringing down home prices even further.

    I have no sympathy for the financial institutions who engineered products that were heavily marketed to people who should not have been given those options and for a government that turned a profitable blind eye.

    For those individuals who milked the system by flipping homes and are now squatters in them, shame on them, but it fails in comparison to the billions of dollars the financial institutions milked the tax payers.

    We had to experience this lesson to learn from it. We will not take out another mortgage, even if it means renting for the next ten years in order to buy a home in cash and with low taxes.

    Despite the crisis we’re in, I’m hopeful that in the long run these lessons will make us more vigilant of the policies our government and financial institutions implement and that as citizens we become more activily responsible and raise hell when we see injustices, like billion dollar bonuses to CEO’s that ship jobs overseas.

  6. Defaults are little more than another symptom of our irresponsible society and irresponsible government. Somehow we have determined that we are all entitled to “own” our homes. Ironically, we have also decided that all real estate and homes will yield a financial profit for us. It’s laughable!

    When that assumed entitlement doesn’t provide the bargain we wanted, people to break loose from contractual obligations. Funny how everyone wants to jump into real estate when the market is up, but when there’s a downturn, everyone wants out. No one planned for a downturn, as a true investor would have.

    Defaults, bankruptcy, bad credit, ‘forgiveness’ is being adopted by more and more individuals, businesses, and governments. Whether a home loan goes into default because the owner has lost a job or the home is worth less than it was originally appraised for (under water) is immaterial. The loan for the home is still regarded as a contractual obligation. Investments involve risks. And risks should be analyzed before taking on any loan, no matter if it is a credit card loan or a home loan.

    A house is an investment, usually the largest investment for many people. Real estate investments in the US have been considered ‘safe’ because an unwritten rule of profit is often realized. When the investment depreciates, the owner-investors want out and are no longer interested. But when the investment increases, the owner-investors are loving life. Imagine if the situation were reversed and the bank wanted the house back because the investment proved to be profitable and was not the same value as the contract originally stated.

    Those who have defaulted and abandoned their contractual agreements should be held 100% accountable. Investors of real estate must plan for losses, no matter what the losses are. Instead, taxpayers in general will be held accountable, bailing the out. And the threat of losing a good credit rating is only as good as the comparibles. How bad is ‘bad credit’ when 10% or more of Americans are rated as such?

  7. I’ve heard of people abusing the system, by walking away from the mortgage, The problem, is that owning a house is not like other investments. If the price of gold, or commercial property you own goes down, you get hurt, but you aren’t living there. I’m sorry Lynn, sometimes life creates problems for people. They can’t fulfill the contract. Illness, loss of jobs etc. Also, as long as we are going to bail out banks, then your arguments are not going to carry much sway. Banks have all kinds of ways to cut their own losses at times like these. But to ask someone who bought a house at artificially inflated prices, {which he had no control over} at say 400,00. and now his house is worth 100,00, and his neighborhood is falling apart because of defaults, is asking a lot. I assure you, the bank would figure out how to do it, if it were them. As soon as we went from trusting a mans word, {and men would fight duels to the death, over accusations against their honor, in earlier times}to filling out contracts, we started heading down this road long ago. It’s this stupid fractional debt money system we have. It turns everybody into liars as soon as the bank gives you a loan, by just “creating” money when you borrow. So while many of these people in the article are just gaming the system, for many people walking out of an oppressive mortgage mistake helps them start over in a sensible way.
    In other words, people have to live within the system we have, not the one we wish existed. My hope is that every one has learned his lesson. But i doubt it.

  8. Sorry, BrierRabbit, but your argument is not logical. Illness and the loss of jobs, as you mentioned, are risks that should be taken into consideration before signing any financial agreement. For those who fear the possibility of certain risks, there is insurance that can be purchased if someone wants to lessen their personal risk, but few opt into having lost-income insurance.

    Bailing out banks is another debate altogether, not really what this post is about, but in truth, TARP was not about bailing out large financial institutions. That was the cover-story.

    Banks do have the means to cover their losses, but so do people via their IRS 1040s. And please, let’s not try to say that banks “create” money — they make money but do not “create” it. The Treasury does that, which, at the cost of the USD, we’re destined to financially collapse.

    I’m a bit confused by your comment, “people have to live within the system we have, not the one we wish existed” because this is EXACTLY what my own points are. The system we have is based on contractual agreements. Since contracts are no longer honored, we have enabled mass financial chaos to exist and the snowballing will affect everyone. While the US is still allowed to pursue capitalism, banks are permitted to be profitable…..So are Americans. For now.

    Words that used to have meaning in the real estate world are ‘caveat emptor’. By today’s standards, those are little more than an empty joke being played on anyone with a financial stake in America.

  9. Lynn,

    If we are going to maintain the contractual nature of real estate, we cannot also maintain that those who have defaulted must be held 100% accountable, no matter what. This is because the contract itself makes room for default to occur, and the process of foreclosure is the natural end to a default. Because the contract allows it, default is not by nature against the contract.

    I know what I have been frustrated with is the number of folks here in CA who have seen this situation as a chance to seek their own gain, a chance for exploitation. This was never the intent of the default/foreclosure process, and that is a loophole in the standard contract that will need to be closed.

    Another loophole which needs to be closed, in my opinion, is the idea that when someone defaults on a second home (there are many, many second homes being let go simply because the owners find it profitable to do so), the bank has no recourse other than foreclosing on said second home. I think that if the law allowed for banks to seek to repossess cars and/or businesses in order to make good on the loan for the second home, we would see owners of these luxuries taking their contracts more seriously.

    Anyhow, all of this was really to say that once we say someone should be held accountable 100%, no matter what, we are actually stepping outside the contract and speaking of an ethical/moral ideal.

  10. Lynn, you make excellent points. Brandy Afterthoughts, you as well.

    We are one of those families caught short on a bad investment. We sold for what we could get and consider ourselves lucky to be out from under. Part of learning investing is knowing when to cut the loss. Rents in our area are high, but we can afford a safe neighborhood, and someone else takes care of the property (our children are small, this has been a blessing). We are regrouping while we figure out our next steps.

    Renting is what we’re planning for the next several years. I don’t feel entitled to home ownership, it’s more important to me to be home with my children than working in order to (maybe) afford a house payment and all that home ownership entails. In fact, as anxious as I once was to own a home, I would highly recommend renting to any couple with small children. While it’s probably not a terrific decade-long strategy, not getting bogged down in the work – and it is work – of maintaining a home as an owner when that effort might be better spent elsewhere is worth considering.

    I appreciate the folks here who can break down and analyze and convey information about the workings of banks, etc. What I think it comes down to, though, is the predictability of human nature, both the lenders who made pie in the sky loans “hoping” the borrower could repay, and the borrowers “hoping” the inevitable changes life brings wouldn’t affect them – we want things that are too good to be true. I see a need for both parties to bear responsibility and work to avoid the negative effects of the blame game – in this case, a housing meltdown. I reject the “predatory lender” label assigned to banks who were only one part of a greedy equation – all concerned should correct their bad behavior and pay their fair share. I shouldn’t have to pay for any of it.

  11. both the lenders who made pie in the sky loans “hoping” the borrower could repay, and the borrowers “hoping” the inevitable changes life brings wouldn’t affect them

    Goldman Sachs knowingly participated in loans to people they knew couldn’t pay. How do we know that? Because they sold them off and then shorted them (i.e. made very profitable bets against them, knowing they’d tank and then making a handsome profit from it). Short selling is perfectly legal, but what they did was fraudulent and evil.

    In a normal society, they’d be strung up by their heels and run out of town. But somehow in our twisted society, we’re talking about sharing blame while people lose their homes and the banksters continue raking in billions backed by the taxpayers. It’s insane.

    Lord knows the big banks aren’t suffering any under the consequences.

  12. From an individual viewpoint, trying to decide what is ethical, why does it matter what Goldman Sachs or Morgan Stanley did? Who sets their ethical standard according to “What would Morgan Stanley Do”?

  13. Well, I suppose the ethical question would be “How does one deal with a known thief?”

    ISTM that your moral responsibility to someone who you discover is trying to rip you off isn’t quite the same as someone who is trying to deal honestly with you.

  14. In what sense were mortgage lenders or stock brokers trying to rip off the people who wanted to buy real estate or stocks during during a bubble? Who doesn’t know that stock prices and home prices sometimes go down, economic downturns happen, layoffs happen, adjustable interest rates sometimes go up, etc.? People may have been in denial about the risk, but they had the information they needed to evaluate the risk they were choosing to take.

    People should be free to risk their own money, whether it’s in a housing bubble, or a stock bubble, or a lottery ticket. They should be free to put all of their 401k money into a stock shares of a dot com promising same-day home delivery of movie rentals (I’m not making that one up). But then if that investment flops, they don’t have much room to complain. The ones who gambled and won as the bubble was going up aren’t complaining, of course, but you can’t just stop the ones who are going to lose because you don’t know who is going to lose until later.

    Also, a mortgage default hurts both the borrower and the mortgage holder. Both the borrower and the original lender were gambling that the housing bubble would burst later, not sooner. A lot of banks and other lenders are belly up because they, like the borrowers, didn’t do a good job of evaluating risk.

    And also, GS took a risk by shorting the junk mortgage market, if that’s what they did. Nobody can predict when a bubble will pop, because bubbles are irrational. A lot of contrarians got clobbered in the stock market bubble because they were “sure” it had to collapse very soon, only to find that it kept going, and going. GS took that risk, betting that the collapse would be soon (or perhaps just hedging another opposite risk of theirs). Someone else took the other side of it, betting that the housing bubble would continue. GS turned out to be on the better side of that, but either side could have lost.

  15. Amy Scott, I appreciate that you feel compassion for folks who are losing their houses, we all do, but why did they borrow the money? It’s greed, wanting something that looks better than what we’ve already got, insisting that we can outrun stupid if we only have _________ (name that material want). Sorry, I agree some of the lenders were acting in bad faith, but that doesn’t absolve the borrowers of their own bad behavior. Buyer beware applies to the fine print on the contract, not just the condition of the property. Blame belongs to both sides here. Turning a blind eye to the inevitable adjustment upward of the ARM I signed up for, or not bothering to educate myself to the realities of real estate cycles is MY fault, not the banks. There are no victims here.

  16. Cottage Child,

    I don’t feel compassionate toward borrowers. I do, however, think we ought to differentiate between stupid and illegal.

    D,

    I’m unsure how to reply to your comment…. In a free market, the banks that made risky bets would’ve failed.

    Nobody can predict when a bubble will pop

    You can when you create it and control it. I don’t think you appreciate that the banks run the government and set policy and interest rates.

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