Rich more likely to walk away from mortgage

http://www.nytimes.com/2010/07/09/business/economy/09rich.html?_r=1&hp=&pagewanted=all

by yummyfajitas • 16 years ago

49 90 16 years ago

TylerJewell8• 16 years ago

Both my girlfriend and I have been pursuing strategic defaults on our primary residences in the state of California. Her property is underwater by 300K. Mine is about 250K. Neither of us are wealthy, but the financial upside of pursuing this route is very compelling.

In California, if the loan on the home is a purchase money loan, which is the one used to purchase the home, and not refinanced, then in a foreclosure situation, the banks are not in a position to pursue you for a personal deficiency. In other words, they cannot sue you for the loss on the home. We had our lawyers check this out and it's due to laws dating back to the Depression era.

At the time that a house is sold, there are three parties agreeing to the price: the buyer, the appraiser, and the mortgage lender. So if a home goes down in value, all parties share the risk. It's no different than a VC investing in a small business. If the business fails, the VC cannot sue the managers of the business to get their money back. The same holds true with foreclosures in California. In the depression, this same situation happened, property values fell, people lost their jobs and were sued by the banks to pay them back. Bad stuff.

We are both pursuing short sales of our homes, but are perfectly OK with a foreclosure. In both situations, our credit ratings will take a huge hit, but they recover in 7 years for a foreclosure, and in 2 years if it's a short sale. So we asked ourselves, is our credit score worth 300K? And with some simple financial modeling, we figured that it was about 10 years for the property values to break even. And the trade off was simple.

The short sale does turn into cancelled debt, though, and the IRS will get a 1099-C. Cancelled debt counts as income, which makes it taxable. Except the US govt passed the 2007 mortgage debt relief act, which makes cancelled debt from a mortgage tied to your primary residence an exception. You do not have to pay income tax on it. This is valid through the 2012 calendar year.

At the state tax level, if the home has cancelled debt, it's still seen as a loss sales against the orginal value of the home. And losses are not taxable.

So this is a great situation financially - no liability to the mortgage company, no federal or state tax. Really bad credit for a couple years :(. But as a question of opportunity cost, this seemed to make the most sense.

In order to pursue this, both of us had to stop making all payments on the mortgages. We both got harrassing debt collection calls for awhile, but once you get into the foreclosure process, they eventually die down. We each will get 6-12 months of living in our homes for free, so in some ways that is a loss recovery.

Hope this helps some of you...

jdminhbg3• 16 years ago

"Her property is underwater by 300K. Mine is about 250K. Neither of us are wealthy..."

I realize that "wealthy" is a hopelessly vague relative term, but unless your houses are literally worth $0 now to put you $550K underwater, most people would consider you wealthy to have bought them in the first place.

jakevoytko• 16 years ago

Chris Rock has some good input on the subject:

"Shaq is rich. The white man who signs his check is wealthy."

If you're rich, you can buy an expensive house. If you're wealthy, you can forget exactly how many expensive houses you have.

TylerJewell8• 16 years ago

Hello, jdminhbg. It's an interesting point that you make, but here is the real situation with my girlfriend. Do you still think that she is considered wealthy?

- She has been employed as a licensed clinical social worker for 11 years with a county in california. - She owned a condo for 3 years, sold it, made 100K profit. - She used that 100K as a down payment on her current home. - She bought the home for 500K, 400K 30 yr fixed mortgage. - She bought the home 6 years ago. - Today, she owes $370K, and the BPO of the home is 170K. This is commensurate with other homes in the area.

- She has 30K in the bank and a pension plan with the state of California.

She is still employed with the county, but they are pursuing layoffs in social services. Her job is at risk. Technically, she is insolvent, as the 300K owed is greater than the 30K she has in the bank. Her retirement pension doesn't count towards solvency.

So a set of circumstances where she used the profits from one investment, and placed all of those profits in another investment to buy a nicer home for herself has turned sour. Her salary let her afford the 400K mortgage, but she wasn't able to save or invest in other items.

She didn't have tremendous wealth, but she did have skills and a job that would allow her to continue payments against a loan, at the cost of not being able to afford any other investments.

When this is all done, she'll have 40K in the bank from saved mortgage payments, a pension, her job (hopefully), and bad credit.

Sukotto• 16 years ago

Do you have a blog or something where you walk through the legal and financial calculations you made? I'm really interested in seeing how you enumerate and evaluate your options.

TylerJewell8• 16 years ago

Sukotto. Unfortunately, no, I didn't publish the financial calculations that we made. But I can walk you through the basics of the analysis. We modeled out a few different scenarios: - Real estate appreciation at 1%, 3%, 5% compounded. - Whether we stayed with them as primary residences, or convert to rentals. Assumed that rental rates are mostly flat. - In primary residences, we accounted for tax deductions from mortgage interest. - We then made assumptions about the debt cancelled by taking the fair market value of our homes, minus the debt we owed, plus another 10K for unknown selling costs we would incur. - We then estimated some sort of "cost" that we would both incur for having low credit for up to 7 years.

We then modeled all this out, and took a look at our net worth in 10 years on the assumption that we sold our homes at that time. We assume a 7% transaction fee for selling the homes.

In both of our cases, we came out ahead in all scenarios by pursuing a foreclosure. We figured out that we needed our houses to appreciate at 11% annually for 10 years in order for holding onto the home to be more profitable.

One last note, neither of us have large families, so we don't have the history, memories, fondness, and attachment to the homes that would have made this choice much harder. Fondness is something that can't be reasoned in spreadsheets.

rada2• 16 years ago

I am a big fan of Mish's Economic Analysis blog. He has covered the topic many times.

http://globaleconomicanalysis.blogspot.com/

(Make sure to read comments, and be very careful - your legal leeway differs greatly from state to state).

Also, google "Intentional Foreclosure" or "Strategic Default" + "your state".

hugh3• 16 years ago

Do you lose any sleep over the ethics of it?

dminor• 16 years ago

Ethics? According to their contract, if they stop making payments the bank gets the house. There's nothing unethical about exercising that contingency.

chengas1232• 16 years ago

I lose sleep over people suggesting it is unethical. That is buying in hook, line, and sinker to the propaganda these companies would like you to believe. Deciding not to service debt is a tactical business decision made every single day. The same companies suggesting it is immoral in order to increase their own profits at the expense of struggling homeowners have all done the same exact thing without anyone ever suggesting it is immoral. You are choosing to exercise a clause of your contract and have every right to do so.

Also, declaring foreclosure is doing a great public service. It helps still inflated housing prices reach affordability. Californians spend more on housing than residents from any other state. If we were able to spend less money on housing it would have a positive impact on quality of living here.

TL;DR: I would trade my credit score for $250k in a heartbeat.

dgabriel• 16 years ago

This is an interesting article that explores the ethics and morality of walking away from a mortgage.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1597835

Frankly, I'm torn about whether or not I would do the same in a similar situation. I hope I never find out.

TylerJewell8• 16 years ago

Someone asked me if I am losing sleep over the ethics of the situation. I think there are two separate issues:

Ethically. I'm ok. This is because a mortgage has pre-arranged clauses in the contract that outline what the exit criteria are for the bank and the borrower. It's a contract with a pre-negotiated process around a divorce. A prenuptual if you will. In this case, we are just choosing to execute one of the clauses in the contract, as any business has the right to do. So, there is nothing unethical about adhering to the contract.

Morally. There are concerns about short sales and foreclosures bringing down property values in the neighborhood. And that is an overall market affect. And there is a concern that this action brings down the overall market. It's the same as what happens when the stock market has a sell off - every time a stock is sold in repeating fashion, the overall value of the market declines as there is more cash on the side. Morally, I am personally ok, because the expectation with me and my fellow neighborhood residents was that we were all seeking asset appreciation, and when that didn't occur, there was an understanding that we may all have to pursue options to rectify the situation. I was open with my peer group about that 5 years ago when first buying the property. If I had lied about my intentions, it would be a different story.

Also, and I forgot to mention this. In both of our cases, we have changed our job situation such that it is not profitable on a monthly basis to continue paying our mortage and there is no refinancing situation that makes it profitable. And we both explored conversion to rentals. We'd be in a situation where monthly, we were expending nearly 3K / month in losses if they were both rentals.

patio113• 16 years ago

If anyone needed further confirmation that people respond to incentives, there you go.

TylerJewell8• 16 years ago

This information was in a footnote in the morality paper that was submitted by another contributor. A "deficiency judgment" is when then bank can pursue the borrower to pay back the amount of the loss after a foreclosure. What's compelling about the footnote is a list of the states that offer non-recourse loans, which prevents banks from pursuing deficiency judgments.

BTW, one of my banks hired a debt collection agency to pursue the past payments. They are generally customer service oriented and friendly. But I had one encounter with a very aggressive rep who told me that I was required by law to pay, that because their bank was in TN, the laws of California were not in affect, and other inaccuracies. He was out of control and out of line. Just record those conversations, ask for his name, and his supervisor.

"While most states allow deficiency judgments, many states hardest hit by the housing crisis, including Arizona and California, are non-recourse states – meaning that a lender may not pursue a borrower for a deficiency judgment on a purchase money mortgage. See Andra Ghent and Marianna Kudlyak, Recourse and Residential Mortgage Default: Theory and Evidence from U.S. States 5 (Federal Reserve Bank of Richmond Working Paper No. 09-10, July 10, 2009), available at http://ssrn.com/abstract=1432437 (listing Alaska, Arizona, California, Iowa, Minnesota, Montana, North Carolina, North Dakota, Washington and Wisconsin as non-recourse states)."

jdminhbg3• 16 years ago

"While most states allow deficiency judgments, many states hardest hit by the housing crisis, including Arizona and California, are non-recourse states"

Not coincidentally, I would add.

anamax6• 16 years ago

In CA, only the purchase loan is non-recourse. Refinance loans are not non-recourse, that is, the lender can come after you if you bail on a refinance loan.

I'd guess that home equity loans (in CA) are also not non-recourse.

IANAL, YMMV.

pchristensen• 16 years ago

I know someone who is considering going through the same process. How did you go about finding a lawyer to help you with the process? Once you decided to do it, what steps did you to prepare for it?

I'd really appreciate if you could email me so I could ask some other questions my friend has. peter at pchristensen dot com. I could buy you a drink for a few minutes of your time.

icefox• 16 years ago

Where is my 6-12 months of free rent?

Tamerlin3• 16 years ago

I'm in a situation where I lost income after getting laid off, and as a result my mortgage and HOA dues are now close to 50% of my monthly pay after taxes. This makes things rather tight, since I have other bills to pay also.

Equity wise, I'm not underwater, but my place has lost enough value since buying it that I'm close.

The problem is the HOA. They're levying a $16,000 assessment for a repair (decks -- a lot of people have said that this figure seems too high to be reasonable).

Since they're not new decks, the value increase to the condo will be small. I'd have to stay in this place for a few years to break even... but in the process of financing that $16k, I would end up underwater, paying PMI, so my monthly payments would exceed 50% of my monthly income. (It's hard to start a new business with no spare income, too.)

Without the HOA special assessment and the HOA-driven extortion (they're going so far as to threaten to shut off utilities as well as foreclose, throwing extra junk fees and penalties my way in the process), I'd be able to refinance, lower my monthly payment, and be entirely out of debt.

To top this off, all of my options for financing are either credit cards (high interest) that I've been avoiding, or dependent on a high appraisal, which is very unlikely.

So, due to the HOA's assessment, I'm in a situation where my best financial option is to attempt a short sale and failing that foreclose. Though it would hurt my credit, it would also allow me to transition to somewhere with a MUCH lower cost of living (rents are low), and without any debts at all. Which is good for going to into business for myself, because I'd be able save enough money to live on for six months in... six months.

I don't know how things work when an HOA forecloses though. I will be talking to a lawyer to make sure that they can't come after me beyond my property if they foreclose, which they most likely will when they find out that I'm not going to pay the $16k or the $1600 in fees that they're throwing at me (some of which are unexplained, and some of which another person in condo management said might not even be legal).

I will never live anywhere with an HOA again.

anamax6• 16 years ago

> I will never live anywhere with an HOA again.

Good advice. It's hard to follow in many places, but it's still a good idea.

Note that local govts are a "super HOA" in some sense.

SecretAgentMan• 16 years ago

wow - no words about personal responsibility, no self-reflection about what 'your word' means or what it means to agree to a commitment.

Just a plan to weasel out.

I'm flabbergasted.

RiderOfGiraffes• 16 years ago

Here are some earlier submissions on this and similar topics:

http://news.ycombinator.com/item?id=1491252

http://news.ycombinator.com/item?id=1175576

http://news.ycombinator.com/item?id=1011716

http://news.ycombinator.com/item?id=726110 <- This has lots of comments

motters• 16 years ago

It makes sense if you took out an overblown mortgage and are in a big negative equity situation. If that's the case then getting rid of the property as soon as possible is really just about cutting your losses to the minimum.

bsnss-mn-cdr• 16 years ago

Quote of the day: "The rich are different: they are more ruthless"

crpatino2• 16 years ago

Not necessarily ruthless, but money literate.

I'd rather reserve my kindness and good manners for actual people. Banks are, in a way, abstract machines made of policies, rules and procedures. You do not gently talk to your computer; you type the command as outlined in the fine manual.

wheaties• 16 years ago

Banks and businesses have been doing this for years. They weigh the economic impact of supporting an unprofitable entity versus the impact of letting it go. I don't see why people insist that other people are "morally" obliged to continue to pay a mortgage.

A mortgage is a business contract. The banks evaluate you in terms of risk of not paying and you evaluate the prospects of the mortgage contract they write for you. There's no blood oath or secret brotherhood you join.

josephruscio• 16 years ago

There is absolutely no moral or ethical dilemma in "jingle-mail". These banks handed out huge no-money down loans like candy to people who bought way more house (and in some case multiple houses) than they could legitimately afford. Both parties were complicit in a transaction that should never have occurred. Now that the inevitable has occurred and the music has stopped, the only thing that matters is the letter of the law regarding the contract. If the bank proposed/agreed to a no-recourse loan, just walk away.

Morality aside, jingle-mail is also the healthiest solution from a market perspective. The faster banks are forced to take their lumps, move these foreclosures through the market, and return lending standards to their historical norms (e.g. 20% down), the sooner the housing market can return to normalcy.

moonpolysoft6• 16 years ago

I'm currently in the process of walking away from a home out of state. I moved from Delaware to California close to 3 years ago due to a really good job opportunity. I couldn't take the hit in selling our house at the time since it was underwater, so I wound up renting it out. Through that time I have had 2 renters on the property, both of whom wound up walking away from their leases. The last renters trashed the place and I could not afford to get it fixed up enough to rent it out again.

So I was stuck with an unrentable home out of state that I could not afford to fix up and could barely afford the mortgage payments on. Therefore I just decided to simply walk away from it.

Given that context, I simply cannot understand how people can say it's either immoral or unethical to walk away from a house. The loan modifications that banks try to shove down your throat are generally shitty deals, they simply want recapitalize all of your late fees and missed payments back into the principle, putting you further underwater. Working out a more equitable deal with the home retention folks is damn near impossible. Not to mention all of the collections calls and come ons from unscrupulous firms that want thousands of dollars to try and work out a deal for you. Walking away is an act of last resort and the financial and credit penalties are there to mitigate it.

roc2• 16 years ago

> "I simply cannot understand how people can say it's either immoral or unethical to walk away from a house."

It's a social hack, leveraging legacy social behavior.

When loans were primarily between family, friends and neighbors who are not professional businessmen, the social pressure is beneficial to the community. If you took advantage of the lender, the community would be less cooperative in the future.

That no longer being an accurate description of most business deals, individuals are still encouraged to think of legal contracts as being akin to their social/moral 'word' (of honor). This gives an advantage to the businessman who treats it as a legal contract and nothing more.

The individual, once-convinced, will go to great lengths to ensure moral justice, dramatically mitigating the financial risk the businessman agreed to.

e.g. the mark is socially pressured to accept increasingly-onerous terms to try and repay a debt he 'swore' to repay; even though the contract clearly stipulates interest as the price of the businessman's risk in the first place.

Most people just don't realize their tradition is being used against them. The rest are encouraging the stigma because they like being paid interest for one risk level, but actually enjoying a much lower real risk.

See also: credit counseling and debt restructuring as new legal pre-requisites to filing bankruptcy. It dramatically lowered risk of lending, without any commensurate decrease in the cost of borrowing. Yet bankruptcy is still stigmatized as something that only happens to deadbeats and losers. The skyrocketing proportion of bankruptcies due job loss or medical costs are brushed under the rug. The price of interest being the bank's reward for accepting the risk of lending is brushed under the rug.

moonpolysoft6• 16 years ago

Sure, I agree with all that. What I meant by my statement was that I could not understand how a significant proportion of an otherwise entrepreneurial and libertarian leaning audience could be arguing that default is a moral lapse.

TGJ• 16 years ago

"I simply cannot understand how people can say it's either immoral or unethical to walk away from a house"

You signed a contract. That's what makes it unethical to walk away. You put yourself in the position that you are in. You may think you took a better job offer, but actually if you had considered your circumstances, the job offer was not that great because of the obligation to the mortgage company where you lived for the house that you bought.

You say that you could "barely" afford the mortgage payments which implies that you could afford them. The last paragraph of your response is just a list of excuses to make yourself feel better about the course of action that you have taken. Your part of the problem, not the solution.

crpatino2• 16 years ago

The contract carefully outlines what is it to happen in case the borrower finds himself unable to make payments. It is not as if he's stolen the money; he's loosing the property AND the percentage of mortgage payed so far.

The lender is to keep all the cash received so far, and the ownership of the house as well. If the property happens to have been so overpriced that he's loosing money anyway... so bad. They are supposed to be professionals asserting the risk. If they chose to ignore those risk in order to push a deal more attractive to the customer/borrower, guess what, they gambled and they loose!

moonpolysoft6• 16 years ago

Do you feel that bankruptcy is an unethical process? Perhaps we should bring back debtors prison? After all, miscreants like me put ourselves in this position. Should we not pay for our mistakes through indentured servitude if need be? Perhaps we ought to pass our debts on to our children.

orangecat4• 16 years ago

You signed a contract. That's what makes it unethical to walk away.

Is it unethical to cancel a phone contract and pay the ETF?

Your part of the problem, not the solution.

He's helping home prices return to reasonable and affordable levels; I'd call that part of the solution.

rada2• 16 years ago

There is a big difference between regular debt and collateral-backed debt. The whole point of a loan backed by a collateral (in this case, the house) is that the lender gets said collateral upon default. Mortgage lenders are not "screwed" by foreclosures - they would love a foreclosure on a house whose value is up.

Banks do not count on your paying off the house - if they did, they would not explicitly demand your house as a collateral upfront. They are exactly like the pawn shop owner who takes your wedding ring in exchange for some cash. It's not a moral obligation on the part of the owner to buy the ring back if the price of gold goes down to the point where it's cheaper to buy a new ring - so why is it a moral obligation on the part of the home owner to buy the house back from the bank?

Perhaps those rich people are not "ruthless" - perhaps they are rich because they understand things like that.

bosch• 16 years ago

It's fucking pathetic that both banks and homeowners look for a bail out from the tax payers who were fiscally responsible. Why is there no punishment for people being stupid and why should responsible citizens help you keep the house that's bigger and better than theirs with a government bailout? Does anyone have any integrity or pride in themselves anymore?

Walking away from a mortgage you signed is about as responsible as the banks asking for bail outs!

Rich more likely to walk away from mortgage

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