Just Take It Back …

A few weeks ago a writer wrote in describing a “strategic default” on his home:

My house has a $320,000 mortgage, and the current value is about $190,000. I have not made a payment since January 2011. I have told the lender the house is theirs and to notify me when to move out. If they’re willing to give me a new mortgage based on the current appraised value, I will consider it. They refuse to deal with me. Any advice?

In my response, I questioned the logic of the lender making a new loan. Based on the reader’s record, he might again walk away if property values continue to fall. Further, if borrowers can walk when home prices go down, then would it be unfair for a lender to unilaterally increase borrowers’ debt if property values increased?

In closing, I added that given today’s mortgage rates it likely would have been better to make payments and refinance. Such a strategy would have allowed the reader to keep the property and substantially reduce costs.

A number of readers disagreed with my response. Let’s look at their views:

“The person with the mortgage can and if possible should walk away,” said a reader. “The asset value should be written down. The loan portfolio of the bank should take a charge. That’s how capitalism works, for the lender and the individual. The corporation does not make decisions on some perceived notions of fairness – and neither should the individual. After all, this is a contractual agreement. The response to the reader is wrong.”

First, most likely the mortgage was originated by one lender, sold on the secondary market, packaged together with other loans to create a mortgage-backed security. Next, interests in the MBS were sold off to investors, such as insurance companies and mutual funds – maybe even a mutual fund you own. So, not paying typically hurts mortgage investors, not “banks” or the mortgage brokers or mortgage bankers who originated the loans.

Second, a mortgage is a contract. The loan is supposed to be paid back even if the value of the asset falls. Think of a new car. You buy at the dealer, finance, and a month later the car is worth less than when first purchased. Do you stop making car payments?

“How long should we continue to pay for negative equity knowing we stand a chance of losing the house at some point in the future?” asked another reader.

Unlike investments like stocks or bonds, real estate has a “use” value. It’s shelter. In many markets rental rates are rising while home values are falling. You may be better off paying the loan and living in a nice house rather than being uprooted.

“The owner with the $190,000 house really should be saving his monthly payment and wait until the eviction notice, or send the keys back to the lender and walk away. Hopefully he has saved the money that would have gone to the house payments,” said another email.

Is the property in a jurisdiction that allows “deficiency” claims against homeowners? If yes, the borrower may be looking at years of litigation. What about bankruptcy? The so-called Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 did away with many protections for borrowers, and it created new federal protections for creditors. In any case, credit will be ruined for years, especially with recent lender guidelines to punish walkaway borrowers.

“Obviously,” said one reader, “you are not on the homeowner’s side but catering to the real estate business. But then again there is not a single newspaper writer who will dare write on behalf of owners.”

Many reporters have spoken out against toxic lending – and were largely ignored.

For instance, in 2006 – when home prices were soaring – I gave a speech regarding “non-traditional” financing at a national meeting of state real estate commissioners, saying “looming in the background is the potential for financial disaster that will impact home values nationwide, spur foreclosure rates to new highs and devalue insurance funds, pension holdings and investor accounts. The value of your home, no matter how you financed, is at stake.”

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