Is Defaulting On Your Mortgage – A Strategic Default – Right For You
Q: In a column earlier this month, you were asked a question about a consumer who paid $170,000 for her home. She owed $164,000 on a home bought in 2008 and had a $7,000 second mortgage.
Since the decline of the real estate market, her home is only worth about $159,900. She got engaged and wanted to sell and would need to take a loss of $11,000.
I take exception to your suggestion that she just stop making mortgage payments and let the lender foreclose on the home. This is a matter of morality and not finance.
The borrower signed a contract to make the payments and nowhere in the contract did it say that the borrower would be released from the contract if she was to become engaged, or found that she no longer liked the house, or if she chose to move to another location, etc.**
I don’t work in this industry, but it just drives me up the wall when people want to buy a home and ask a lender for the money and then when they no longer want to live in the home or they become “engaged,” they can just solve all their problems by walking away.
If this person stops making mortgage payments, I hope they are sued by the lender. We need to return to morals in this country that honor our contracts and stop blaming others for our mistakes.
A: Your point is well taken. The advice given to that homeowner was not given lightly. Each homeowner must make his or her own choices when it comes to honoring a contract.
But we disagree that morality is the sole reason the person should remain bound to a contract with a mortgage lender.
Every mortgage contract contemplates a breach of contract and the lender has certain rights and remedies under that contract.
If the borrower defaults on the contract, the borrower’s “punishment” might be to suffer the consequences of a drop in her credit score and damage to her credit history. In addition to that, the borrower will have lost any equity (or investment) she might have made into the home.
And finally, the lender might be entitled to sue the borrower for the difference between the amount the lender is able to get from the sale of the home through foreclosure and the amount owed on the debt (a deficiency judgment).
The borrower did not marry the lender or take an oath to uphold the mortgage contract. This was strictly a business deal between two parties.
Several years ago, there was a story in the news about a couple on the west coast that decided to walk away from their home solely because they no longer wanted to make the payments on the mortgage. They could afford the payments and had no hardship to speak of but decided to walk away from the house payment.
In that case, the lender could not sue the borrower but got the property for what it was worth. At the time, we thought that these borrowers should honor the contract and should not walk away.
However, over the last several years, the mortgage and real estate industries have moved in a very different direction.
Many lenders proved willing to make loans to anybody as long as they had a pulse. Loans were given on the basis of whether those loans could be sold off onto investors and no substantial regard was given to the traditional home loan underwriting criteria.
Real estate values were skyrocketing and yet the major ratings agencies’ models did not contemplate or project anything other than a scenario where property values would continue to rise.
And, Wall Street firms sold these securitized investments around the world based on a false premise that these loans were good and that the work behind them was sound. Did any of these bank, lenders or investment companies consider the moral implications of granting loans to people who couldn’t afford them?
Nope. It was strictly business. This has persuaded us to look at mortgages solely as a contract without looking at it from a moral point of view. The decision to default because it is better for the borrower’s financial sheet is has been termed a “strategic default,” and homeowners whose homes are worth way less than the mortgage balance are choosing to default in droves.
Years ago, individuals filing for personal bankruptcy faced a severe moral stigma. Slowly, the moral stigma associated with filing for bankruptcy has faded and in the coming years, we believe the moral stigma associated with defaulting on a mortgage contract will fade as well. And as this stigma has faded, more homeowners are electing to default on their mortgages and move forward with a strategic default. Some, when they do default, simply mail their keys back to their lenders in a form of jingle mail.