You’ve probably heard that a high-profile realty group that had agreed to pay $5.4 billion for a New York City housing complex just announced it was not going to make good on its loans. You might describe the (former) owners as misguided, stupid, or unfortunate. You probably wouldn’t think of calling them immoral. So why is the average homeowner’s decision to walk away or keep up with the payments on an underwater mortgage considered a moral issue?
On NPR, there’s an interesting example of the predicament many homeowners now face. Thad Salter is an underwater homeowner who is actually one of the lucky ones: After swimming through red tape for a year, he was approved for a mortgage modification, which lowered the interest rate from 6.8% to 2% and cut his payment in half, but also extended the mortgage from 30 to 40 years. So what is Salter’s current state of mind? He’s tentatively staying put, even though he thinks it would be smarter to strategically default. Here’s why he’s so tempted to walk:
The mortgage modification solves a short-term problem: It allows Salter to stay in his home. But it doesn’t address a long-term issue. Salter’s mortgage is about $300,000. Today, his home is worth $125,000. He’s underwater.
To keep the bank from taking a loss, the loan modification includes a $107,000 balloon payment before he can pay off the mortgage. So financially, Salter says he feels like a hostage.
“I’m not gonna gain $200,000 value on this home,” Salter said. “That’s just not gonna happen. You know, I think it’s gonna take a lot longer than that to even break even on this house, if ever.”
So what’s keeping Salter in his home? He doesn’t believe in walking away. He signed a contract, and he’s trying to stick to it, even though the majority of his neighbors have done the opposite and entered foreclosure over the past couple of years.
The NY Times points out that many, many people in Salter’s situation—including those whose mortgages haven’t been modified—are dutifully keeping up with their payments:
Why is the mortgage default rate so low?
After all, millions of American homeowners are “underwater,” meaning that they owe more on their mortgages than their homes are worth. In Nevada, nearly two-thirds of homeowners are in this category. Yet most of them are dutifully continuing to pay their mortgages, despite substantial financial incentives for walking away from them.
A family that financed the entire purchase of a $600,000 home in 2006 could now find itself still owing most of that mortgage, even though the home is now worth only $300,000. The family could rent a similar home for much less than its monthly mortgage payment, saving thousands of dollars a year and hundreds of thousands over a decade.
Some homeowners may keep paying because they think it’s immoral to default.
Banks, government officials, and much of society seems to agree that strategically defaulting is wrong—for the individual homeowner, that is. If a realty company, bank, or investment firm does essentially the same thing, however, there is no right or wrong. There is only a good (money-making) or bad (money-losing) proposition.
It’s a double standard, as described in a University of Arizona professor’s paper recommending strategic default as the wisest move for many underwater homeowners. The paper says that there is no moral obligation in the purchase of a home—or, in fact, in the entering of any legal contract. Instead, there is a promise, and the consequences for not following through on that promise are spelled out in the contract. If you default, you lose the house and your credit score takes a beating. You don’t go to hell.
The problem is that the housing market—and all of society, really—suffers when people start behaving more like businesses than like Thad Salter.
Related:
Bad Credit: Not So Bad After All?
