Lenders are pressuring owners to repay their underwater loans by appealing to morality. As people strategically default and their lives improve, they tell their friends which triggers the next wave of strategic defaults. The pressure of morality gets less and less effective, particularly when borrowers realize the false morality to lenders is superseding their real moral obligations to their families.
By Charlotte Cuthbertson
Walking away from a mortgage seemed like a crazy idea to Chris Schreur, a financial adviser, and his wife Valerie thought he had gone mad when he mentioned it. It wasn’t just the financial hit, but the shame of defaulting.
“I think it is the number one reason, by far, that more people aren’t doing this,” Chris Schreur said.
If that is truly why people are not defaulting, then we are going to see more and more strategic default as people realizing their morality is misplaced.
After buying a house during the boom of the mid-2000s, many homeowners are now finding themselves underwater; meaning they owe more than their homes are worth. More than 11.3 million, or 24 percent, of homeowners were underwater by the end of 2009, according to a report by First American CoreLogic.
Finding themselves more than $130,000 underwater on their mortgage, the Schreurs chose to stop making their payments, even though they could afford it. “It was completely crazy to keep throwing good money after bad,” Mr. Schreur said. Their credit score was in the 800s and they had never been late on any payments before then. They owed $430,000 on their California home.
“Objectively the hardest part was the hit to the credit rating,” he said. “Defaulting on a debt is the hardest thing to accept.”
Schreur did some research and found he could get more house for less money by renting.
“My degree is economics, so I understand that you don’t keep putting money into a losing proposition just because you already put money in,” he said.
But it was his child’s future that made the decision clear and helped ease the shame factor.
“I think of it as a choice between either defaulting and writing the debt off now, and potentially not being able to send our daughter to college in 12 years,” he said.
That realization by that borrower, once spread around the country, will cause a stampede toward the exit door.
A borrower’s family should be more important than the ego of the head of the household. When borrower’s take what they consider to be the moral high road, the only people who are going to know or care will be the borrower’s family. The people at the bank couldn’t care less about why someone pays their mortgage. Borrowers are nothing more than a number to them. It is the borrower’s family that pays the price so that the borrower can hold his head high and believe that other people think he is behaving morally. In truth, nobody else really cares. The borrower’s pride and ego hurts their family.
Continuing to pay a bloated mortgage is not a matter of morality. The borrower and the lender have a contractual arrangement, and if this conflicts with the needs of a borrower’s family, the borrower has a contractual right to get out of the onerous payments and divert those resources back to the family unit. In fact, the only moral imperative in this situation is the one between the head of household and the family members within it. The right thing to do when hopelessly underwater and paying far more than rent is to walk away.
When excessive housing payments burden the borrower’s family members — the people the borrower’s really do have a moral obligation toward — then the borrower making the financial decisions is putting the needs of the bank above the needs of their family. If there is any moral imperative, it is to get out from under the crushing debt while there is still time to save the family’s future. The house can be replaced; the family members’ education cannot.
…The threats and stigma of defaulting seems to be the coercion banks are using to stop them from defaulting, said Schreur. “So the [banks think] it’s better to go that route than it is to just renegotiate with the people who, all things being equal, would rather stay in their homes.
“I think a lot of people feel stuck,” he said. “You do have choices. Staying in your house is a choice, walking away is a choice.”
The Schreurs are renting a home a mile away from their foreclosed place for $1,000 less per month than their mortgage payments.
Borrowers who are not underwater and who have payments at or below rental parity don’t walk away. They don’t need to, and they don’t benefit from it. If walking away results in a higher monthly payment, people won’t do it. And properties with positive cashflow rarely decline in value because financially prudent buyers would see the value and support pricing. The entire walkaway phenomenon is a direct result of the false appreciation created by lenders who are being burned by the walkaways. Lenders are getting what they deserve.
Jodi Romanello walked away from the Florida home she and her husband planned to retire in. … After approaching the bank and being turned down for a refinance or lower payments, the Romanellos chose to strategically default and their last payment was in November 2008. …
As with the Schreurs, the shame and moral factor was the biggest stumbling block for the Romanellos.
“The banks are making it sound like a moral issue, like you’re defaulting on something you promised,” Romanello said. “And I’m very angry about it, because first they’re taking taxpayer’s money; and they don’t try to work with you at all.
People should be pissed. Lenders inflated a massive Ponzi Scheme, and when it collapsed, they have the nerve to accept government bailouts and cajole people with morality. Lender’s displayed no morality whatsoever, so why should borrowers?
I predict that by the end of 2010, when someone in lending suggests that is it wrong to stop payment, borrowers are going to laugh at them. The Great Housing Bubble will eliminate any pretense about the morality of repaying bank debt.
… Despite homeowners increasingly walking away from their mortgages, most homeowners continue to make their payments even when they are significantly underwater. A study by Brent T. White, associate professor of Law at Arizona University, examined why.
“Most homeowners choose not to strategically default as a result of two emotional forces,” the study concludes. The first is the desire to avoid the shame and guilt of foreclosure; and the second is exaggerated anxiety over foreclosure’s perceived consequences.
These emotional constraints are “actively cultivated” by the government and other social control agents to encourage homeowners to keep paying their mortgages; “and to ignore market and legal norms under which strategic default might be both viable and the wisest financial decision,” the study said.
The study, “Underwater and Not Walking Away: Shame, Fear, and the Social Management of the Housing Crisis” was released in February.
I recently wondered Why Do Struggling Homeowners Keep Paying Their Mortgages? Dr. White’s study is an attempt to answer that question. His conclusions are difficult to argue with. Once borrowers stop thinking default is wrong, and once they realize the consequences are not as dire as they imagine, many more underwater homeowners are going to walk away.
The only thing keeping debtors in place is kool aid intoxication and the false belief that they will get their money back soon. realtors are already talking up the market as they always do, but look for more kool aid from lenders and the government as both parties are now deeply involved in this Ponzi Scheme.
Jon Maddux, CEO of You Walk Away, said they get a lot of inquiries from people who think that they have to file for bankruptcy—which they don’t.
“It’s a blip on their credit,” he said, adding that most people can apply for a loan in three years after foreclosure.
“It’s important that people understand it’s not the end of the world; it’s not something that will financially destroy them,” Maddux said.
The company has helped about 4,000 people walk away from their mortgages and gets thousands of inquiries per month. Of their clients, 90 to 95 percent have tried to work things out with their lender first, Maddux said.
“The nature of the act of walking away has always been associated with being a deadbeat, a failure, etc,” he said. “But it is now seen as a business decision.”
Strategic default is the natural response to the situation. Once strategic default becomes the norm, the market will truly be entering the capitulation stage of the decline.