When Is It OK To Walk Away From Your Mortgage?


Mortgage lenders absolutely hate borrowers who walk away from underwater mortgages, especially those who could actually afford to keep paying off their mortgages but just decide it isn’t worth it. They hate them so much that the term-of-art for these borrowers is “ruthless.”

But the ethics of mortgage lenders don’t have much to recommend them. We need to decide for ourselves whether or not there’s a moral obligation to keep paying off a mortgage. For some it’s practically a patriotic duty. For others it’s a matter of being a good neighbour, since foreclosures could hurt their home values also. Still others say it’s just a matter of being a moral person who keeps promises.

On the other hand, lots of will just tell you it’s wrong to think in these terms. Contracts are economic arrangements, not marriage vows. They can be broken, so long as you are willing to pay the cost. For mortgages, it was well understood by everyone entering into the arrangement that there was a risk the borrower would walk. That risk, in fact, was priced right into the mortgage itself. By walking away, a borrower just exercises an option he has already paid for. So it’s just a matter of economics, not ethics.

Who is right? Who is wrong? Barry Ritholtz’s Big Picture blog has a clip from CNBC that nicely illustrates the debate. In the clip from CNBC’s On The Money, a borrower asks why he should continue to pay for a home for which he owes so much more than it is worth. He bought the home for $600,000 and put a 50% down payment on it. Now he owes $350,000 due to negative amortization but the house is only worth $270,000. The loan is scheduled to adjust soon and his payments will double.

The hosts of the show go absolutely bonkers, berating the borrower for considering walking away. They raise a number of quite silly points. For instance, they say that the guy will damage his credit rating if he walks away. Well, that’s true as far as it goes. But odds are that his higher cost of capital will not amount to $350,000, which is what he owes on his home. And his credit will recover long before the price of his house does.

Here’s how the Big Picture describes the scene:

The hosts gang up on this guy relentlessly essentially blaming him saying a) you made a contract that you must repay b) even if you have to give up your kids education you made a commitment c) you will drag down all your neighbours value d) you will not be able to ever buy or rent d) you are getting ‘value’ by staying in the home because its a place to live e) you have to take responsibility for your action f) you likely lived beyond your means and now you have to sacrifice g) pay extra to principal to make it up. etc

The homeowners do not stand a chance against thinking like this. As we exit the ‘Subprime Implosion’ and into enter the Alt-A, Pay Option, Jumbo Prime and Prime implosions presently happening simultaneously in various degrees, this will be the primary reason people default. I am afraid this is just a little taste of the type of attacks we should be prepared for.

We’re not taking sides here. Let us know what you think.

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