I read an article recently on the site Get Rich Slowly titled “When to Walk Away From a Bad Mortgage“. The title of the article bugged me a little. For that reason, I wasn’t going to read it. I wasn’t all that interested in reading someone’s words of advice to the masses about how it is acceptable to sidestep your obligations. However, I noticed that the article was stirring up quite a bit of heated debate, so I wanted to see if my take on the article was the same as most other folks.
What the Article Said
Once I actually read the article, I concluded that the title really didn’t capture the message that I thought the author was trying to convey. It really wasn’t a how-to for debt shirkers, but a listing of alternatives and issues to consider if you are in a bad mortgage situation. In fact, I would go so far as to say that the author suggests that homeowners consider the listed alternatives instead of simply walking away.
It seems that a lot of other folks got riled up from the title and felt that the whole concept was morally wrong and took issue with the topic. Then, other folks got worked up that folks would take issue with the ‘strategic default’ concept on moral grounds and there was a pretty good back and forth. The moral argument was that consumers should take responsibility for their actions/debts and therefore walking away is irresponsible/immoral. The counter-argument was that businesses do it all the time and that sometimes walking away is simply a good financial move. Further, these folks argued that bringing morality into the discussion makes the decision emotional and that should not be.
If someone were to ask me for advice regarding whether or not they should walk away from their mortgage (and many folks have asked me just that), I would ask them to ask themselves many questions so that they may make their own decision. When one is considering walking away from a mortgage, that means that they are willing to vacate the home and are not willing (or able) to make the mortgage payments. The question is why? One issue in strategic defaults has been the ‘herding effect’ that we are used to hearing about with regard to investing. This means that at times, individuals will follow the crowd instead of making their own informed decision about how they should behave in a specific situation. In the housing crisis, many folks were unable to pay their mortgages because of real economic hardship. A rise in mortgage defaults led to an increase supply of homes (often in markets where supply was already high) and contributed to a decline in home values. This steep decline often left homeowners who could pay their mortgages with homes that were worth less than they owed (the dreaded ‘underwater’ condition). At this point, we began to see a rise in ‘strategic defaults’ as the folks who could pay refused to pay because so many of their neighbors had defaulted, driven their property value down, and sometimes caused the neighborhoods to suffer due to decreased public services and increased crime due to high vacancy rates. These folks were frustrated and gave up. Others realized that the parameters of their loan were not what they thought and walked away in anger. These too are emotional decisions and I will be the first to side with the group that says that emotion should be stripped away from any financial decision.
A strategic default assumes that a person who has the capacity to pay decides not to pay for some reason. So again, I ask the person contemplating a strategic default, “Why“? Are you frustrated? Are you angry? If so, I would argue that anger and frustration are rarely good reasons to make a significant financial decision. Has the housing market in your neighborhood deteriorated to the point that you need to move immediately out of concern for your safety? If so, do what you must to keep your family safe, but understand the consequences of any action that you take that causes you to default on the terms of your obligation. With any debt, you are much better off confronting the problem than doing nothing. Contact the financial institution and explain your situation. If you need to get out fast, perhaps the financial institution will agree to a ‘deed in lieu of forecslosure’ where you effectively sign your interest in the home over to the bank in exchange for them agreeing not to begin foreclosure proceedings. You would typically need to be in default before this is possible, but the biggest advantage to the borrower is that once you are in default it is a fast resolution. A short sale is another possibility, but you would actually need to find a buyer who is willing to pay an amount that is acceptable to the bank even though it would be less than what you owe. Of course, finding a buyer for a regular sale is the best case scenario as it would allow you to sell the home at a price that would satisfy your obligation. The difference between these alternatives is time and how much of the debt you are able to satisfy — either through a sale (short or regular) or by simply handing over the property. Of course, the more you can satisfy, the better off you will be (with regard to your credit and any recourse from the lender). If a person is considering strategic default because they realize that they have committed to a ‘bad’ mortgage, they will have to define ‘bad’. Is it fraudulent? Was the agreement executed without proper disclosures? Or, are the terms of the agreement (interest rate, penalty clauses, etc.) unfavorable for the buyer? These are important questions because if the mortgage is potentially fraudulent, then the borrower should retain an attorney in order to seek a legal remedy. However, if the terms are unfavorable, the borrower likely does not have legal recourse, but should contact the financial institution and attempt to renegotiate the terms of the agreement.
The Bottom Line
Once a contract is executed, both parties are obligated to fulfill their duties as outlined in the contract unless the agreement is found to be invalid. A shift in the economic climate — no matter how extreme or unexpected — is not enough to invalidate the average mortgage contract. However, these situations do give rise to significant foreclosure prevention (and intervention) resources that borrowers can tap into. Should a borrower find himself in a situation where he cannot or feels that he should not pay, he should seek financial and/or legal counsel to explore all possible means of addressing the issue — whatever it may be.