Saturday, July 10, 2010

Is It OK to Walk Away from Your Mortgage?


I came across this article in the NY Times yesterday, which seemed to imply that there was something wrong with walking away from a mortgage. A complete bunch of crock, as far as I am concerned. I know this position will likely draw some fire from those who believe that there is some sort of moral obligation involved here, but that's nonsense. Just like any other business transaction, a mortgage does not carry any moral obligation with it - it is merely an agreement between two parties in which they allocate the risks and the rewards of a  given business transaction.

The two sides enter into this transaction in a very deliberate way, each knowing exactly what risks they are accepting and each hoping to get as much out of the deal as they can. The written contract between them is all that binds them, and the types of re-course they agreed upon in it are all that they have a right to expect.

In a typical non-recourse mortgage agreement, the bank is fully aware that at most they will be able to take possession of the house. No one is forcing them to enter into this relationship, they are doing so of their own volition. If they so chose, they could protect themselves by insisting that the borrower put more of his own money into the transaction to make sure that the asset is worth more than the loan amount. If they underestimated the risk, or chose to enter into a losing transaction, it is their own bad choice.

The borrower can choose to continue to pay his mortgage even though the asset securing the loan is worth less than the loan amount, but that is not a rational economic choice. The government and the banks are running a morally bankrupt campaign to portray strategic mortgage defaulters as immoral. What's immoral is trying to get people to act against their own financial best interest, and grant the banks protection from what is nothing more than a bad business decision.

Defaulting strategically is simply the exercise of a contractual right negotiated by borrowers in non-recourse loans. Indeed that is the whole point of a non-recourse loan. Your exposure is limited to the capital you put into the deal. The lender willingly accepts the remaining risk. This is why the lender gets  his own appraisal of the asset value as part of the deal.

Moreover, in mounting their campaign to discourage strategic defaulters the government and lenders are protecting the more powerful side in the deal. The banks are the sophisticated party in the financial transaction. It is they who practically dictated the deal terms to their borrowers, who are in a vast majority of cases simple homeowners. They deserve no protection from their own economic choices.

There is no shame in walking away from a mortgage. No sense in protecting a sophisticated bank from their poor business decisions, at the expense of your family's financial security. There may be reasons to avoid walking away - the most important being the credit score hit - but there is certainly no moral obligation to keep throwing money down the drain.

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Kim Stiens said...

That's a really interesting perspective, especially the parts about staying in the mortgage not being the rational economic choice. And I completely agree. If banks need not feel morally bad for forcing bad terms on their borrowers in practically every transaction they do, individuals need not feel bad when they can screw the banks over legally too.

Zachary said...

How about the moral obligation to meet a commitment? If meeting a financial commitment is not legally binding, then must surely at least still be morally virtuous to do so.

Shadox said...

Zach - you see, that's exactly what I am objecting to. There is no moral commitment here. There is only a commercial contract that allocates risks and rewards.

Price depreciation is a risk that the lender knowingly accepted in the contract that he (most likely) imposed on the borrower. If this was a concern, they could have required a deeper financial contribution from the borrower or alternatively, could have required additional collateral in addition to the asset.

Claiming your legal rights under a contract is not immoral. Trying to convince you to not stick up for yourself IS immoral.

Many of these borrowers are lower income families whose financial security would be seriously jeoperdized by volunteering to give money to the bank in spite of their LEGAL ability to walk away. Why shouldn't they exercise their legal right?

Zachary said...

I think it is consistent to claim that not defaulting on your mortgage is morally praiseworthy, but also that defaulting is not morally blameworthy.

In other words, I don't think that monetary issues, mortgages or otherwise, are completely morally neutral.

People who walk away from mortgages may not be to blame, but it is still expected that they try not to default when possible.

Rob Bennett said...

I applaud you for making a case for a controversial position, Shadox. We need to hear both sides.

I believe that there is a moral requirement to honor an agreement to make mortgage payments. However, I also believe that there is a moral requirement to avoid helping a runaway bull market cause even more damage by continuing to buy stocks after prices have risen to insane levels of overvaluation. I see moral hypocrisy in the criticisms of many of those who have followed Buy-and-Hold strategies (which did harm to the economy which we all need to make use of to make a living) have directed at those who have walked away from their mortgages.

I think we need to call a national time-out and think through these issues with greater care. I believe that we need to have ethical (not just legalistic and contractual) rules apply in money transactions. Otherwise, trust will be shattered and our free market economy will collapse. However, I think that so many people have crossed so many lines in recent years that it has become unreasonable to point the finger at any one group.

We all permitted the bull market to get out of control. We all need to look at the man or woman in the mirror before becoming too easy in our judgments of others. We need to come clean and begin a national rebuilding process. We can do this. But we first need to become disentangled from the defensiveness we all feel over the ways in which we have behaved poorly and thereby contributed to today's troubles.

Let's not wait until we are in the middle of a Second Great Depression. Let's all start talking turkey now!