When the real estate market took a nosedive 3 years ago people who had bought at the height of the market (including my wife and I) found themselves in a situation where their homes had dropped significantly in value. For many folks, since the drop in home value was significant (sometimes upwards of 20-30%), they found themselves in a situation where they now owed more on their home than it was currently worth.
Since so many people were buying homes without a down payment, and with sub-prime loans, a lot of people are now coming up with a huge case of buyer’s remorse.
According to a report by First American Core Logic, a real-estate data firm, more than 11 million families are in “negative equity”, that is, they owe more on their home than it is worth.
My wife and I thankfully aren’t underwater because we made a 20% down payment on our home, but I know not very many people didn’t plan ahead as well as we did. So what about people who are finding themselves underwater supposed to do now? A growing group of people are saying that for most of those people it would make complete sense to just walk away from their mortgage, stop the monthly payments, and take the credit score hit of a foreclosure instead of allowing yourself to wallow in an underwater home. They call this making a “strategic default“.
My question is this. Is it really ok for people to walk away from an underwater mortgage – even if they have the means to continue paying the bill? Should it be purely a mathematical and contractual equation, or are there more questions that need to be asked?
I found this graphic over at Credit Loan that takes an in depth look at the foreclosure crisis, and asks the question, is it ok to just walk away from your underwater mortgage? Click to enlarge.
[Source: Credit Loan]
Some interesting stats from the graphic:
- More than 11 million families, a quarter of all families with mortgages, are currently in “negative equity”.
- More than 5 million borrowers are more than 25% underwater.
- Some of the hardest hit states include Nevada (65%), New Mexico (47.9%) and Florida(44.7%).
- 25% of renters and 17% of homeowners believe it’s acceptable to walk away from mortgage payments.
- 59% of Amerians say it is unacceptable to walk away from a mortgage
Impact Of A Foreclosure On Credit Score
One of the things you need to consider when walking away from your home and mortgage is the impact it will have on your credit score. Now, I’m not one of those people who will tell you to constantly check your credit report or score and rely on it for everything, but the fact is that more and more people are taking credit score into account when making lending decisions, hiring decisions and more! You ignore your credit score at your own peril.
So what will a foreclosure or delinquent payment do to your credit score? Fair Isaac pulled back the curtain a bit and revealed a little bit about what kind of a credit score impact those things might have:
- 30 days late: 40 – 110 points
- 90 days late: 70 – 135 points
- Foreclosure, short sale or deed-in-lieu: 85 – 160
- Bankruptcy: 130 – 240
Having a late payment, a short sale, foreclosure or bankruptcy will have a pretty big impact on your credit score. Whether you like it or not you may have to work pretty hard to fix the damage you’ve done.
So what kind of an impact can having a lower FICO score have?
Absorbing a big credit-score hit can make many transactions more costly. It’s not just paying more for credit card debt and auto loans, insurance can cost more as well.
The average savings for someone with a good versus mediocre credit score is about $115 a year for auto insurance and $60 for home, according to Loretta Sorters, of the Insurance Information Institute.
A low credit score can even make it harder to rent a home because landlords often use credit scores to weed out prospective renters.
So defaulting on your mortgage is most likely going to mean that you’re going to have start paying more for other things that you buy – and it will be harder to get credit or a mortage in the future. So if you’re considering walking away, remember that it will have a huge impact on your financial life.
Walking Away Has Tax Implications For Many
If you walk away from your mortgage and the bank forgives part of your loan, in many states, any part of a mortgage that the bank forgives is reported as taxable income for you.
So, for example, say that you default on a $150,000 mortgage loan. The bank sells the property for $100,000. If the bank has the right to pursue you for the remaining $50,000 in your state but doesn’t, that “forgiven” amount is taxed to you. That could mean a pretty large tax bill.
For more details on if your state is one where you could potentially be taxed, check out this post: Tax Implications Of Strategically Defaulting On Your Underwater Mortgage
Question Of Ethics Or Just A Contractual Transaction?
Walking away from a mortgage will have a negative impact, and it may even mean a sizable tax bill, but for many people that isn’t enough to stop them from moving forward with walking away. For many while they can currently afford to pay their underwater mortgage, they just don’t want to just lose $50-100,000 in value on their home. Why take the hit when the bank would be able to take the hit for you? Defaulting seems to be the easy answer.
So that brings us to the question – is it OK for a homeowner to walk away from an underwater mortgage, even if they can still pay? Is a mortgage solely a financial and contractual question, or should there be a moral and ethical component to the question? Are you morally obligated to pay if you can?
Many would say that a strategic default is a legitimate option that is even spelled out in the mortgage contract, where specific ramifications of a foreclosure or short sale are spelled out for the homeowner. To exercise those options is just a a part of the legal transaction.
I understand that argument, but don’t completely agree with it. Just because the ramifications of a default are spelled out in the contract doesn’t mean it’s the right thing to do. When you sign up for a mortgage, you should understand what you’re getting into, and not be buying a home that you can’t afford. Home values don’t always go up (despite the conventional wisdom), and you shouldn’t be counting on it as a source of income in the future – it’s just a place to live. I just think that if you sign a deal and a contract, you should live up to your end of the deal.
What do you think? Are there things I’m not considering? Do you feel I’m far off base? When do you think it would be ok to strategically default – or is it ever ok? Tell us what you think in the comments!
We bought our Florida a home about a year before the market peaked. The 20% we put down really doesn’t make much of a difference. We bought it for $185K and would do well to sell it right now for $60K. We currently owe close to $140K. Our sole reasons for not walking away are that we so far have the ability to pay the mortgage and we believe that we should honor the commitment we made to pay it. A lot of people think we are crazy, (especially since we are in the same boat with our rental property as well)!
Biblically every 7 years all debts were to be forgiven. That 7 years was the basis for the year of jubilee. (7 X 7) = 49 the next year being 50. In that jubilee all foreclosed homes were to revert back to the original homeowners family. The Bible says over and over “when a man becomes poor” and God makes a way of redemption for the poor. So yes its biblical to walk away especially given this whole scenario was created by evil greed. And unless you had put 50-60 down you’d be underwater where I live.
I disagree for the following reasons.
a. We don’t live in a OT/Jubilee economy. in that economy people probably wouldn’t be getting sub-prime or zero-down loans.
b. The scenario is not a poor home-owner, but one who still has the means to pay, when the home value has lost market value.
c. Jesus said “Let your yes be yes and your non be no. (Matt 5:37)
No, it’s not Biblical to walk away from our commitments.
When someone strategically defaults they are affecting more than just themselves. That causes home values in the whole neighborhood to drop considerably. As tempting as it may be to ‘just walk away’, I respect my neighbors too much to negatively affect their home investments. Likewise, I hope other people have the same respect for me (although most people are only looking out for themselves).
A home should never be considered an “investment”. It’s somewhere to live and your primary goal should be to take care of your family first. I wouldn’t sacrifice my family to keep my neighbors happy.
Peter Anderson says
I agree that the times of thinking of a house as an investment may be behind us – at least for now. But in the case of a strategic default, by definition you can still afford it, your family won’t necessarily be harmed. You just choose not to pay it anymore because you don’t like the situation you’ve found yourself in. For that type of situation I’d have to agree with Kim that it’s pretty rotten to default. If I had no other choice, and my family is going hungry? Yes, that’s a totally different situation.
I think it’s only rotten when you’ve signed up for a $0 down loan, then milked the low rates and stopped paying and live for 1.5 years mortgage free. I don’t think that most people are in this boat. There will always be unscrupulous people out there.
This idea that most people are getting away with something or cheating the system doesn’t make sense to me. Someone who is losing out on their 20% down is taking a hit and their credit is screwed for up to 7 years. Plus, the bank is by definition taking a risk every time they make a loan. And, if the borrower doesn’t put 20% down, they have to pay mortgage insurance which mitigates the event of a default. Yes, it may be inconvenient for the lender, but it’s not like they are losing hundreds of thousands of dollars. They simply resell the house and move on.
Deut 15 is where you’ll read about this. Another thing to consider is loss of jobs. How can you ethically pay for a loan when you can only afford food for your kids? easy to judge others when we ourselves have a job. Random fact…before the bankrupcy laws changed you could only file chap 7 every 7 years. That came straight from Gods word. Gods grace for us is there even when no one else has grace for us.
Money Beagle says
I wrote about this over a year ago. I’m in the camp that if you can afford to pay it, you should pay it. After all you did sign up for it.
We paid 20% on our home in 2007. It had already gone down in price over 15% so I was pretty happy and thought that we’d gotten a good deal. Well, it’s gone down another 15-20% since so we’re pretty much even keel at this point.
Sucks but even if it fell further, I’m going to pay as long as I can afford it.
After all, you did sign up for it, and eventually the payments will bring you back above water. Most people are too short-sighted to realize that.
http://www.moneybeagle.com/2010/02/did-banks-force-you-to-sign-your.html is my original article on this topic.
as long as you are taking care of your family then keep paying. If circumstances change and you have to choose between your family or your loan, your family comes first. The Bible is very clear about a man who doesn’t take care of his family being worse than an unbeliever.
Peter Anderson says
I think this post is talking more about people who are strategically defaulting – in other words they’re not paying because it makes sense to them financially, not because they can’t afford it. To me that situation and one where someone literally has to choose between food and mortgage is a very different situation.
The Bible does make distinctions between the wicked man who doesn’t pay his bills (intentionally not paying due to greed) and when a man becomes poor (Deut 15)
Before the real estate market crashed, a neighbor refinanced his house, took 100K out of it, then intentionally walked away from his house and bought a yacht. The Bible would define this man as evil.
A friend of mine who’s business has suffered drastically, he is in his ’60’s and can barely afford life let alone a house payment is foreclosing. (a man becoming poor)
I believe you need to read the word to distinguish the motive for walking away. If you become poor, the last thing you’re worried about is your FICO score.
I truly encourage everyone to read up on God setting up his theocracy in Deut specifically about the year of release – the 7th year. Its facsinating. All debts & endentured servants were to be release. This is why Jacob had to wait 7 years to marry Leah & another 7 years to marry Rachel. This sabbath year also applied to not growing crops that year to give the land a rest. Its also related somehow to the kinsman redeemer we read about in Ruth.
And then of course this all culminates in the year of jubilee, where all debts were forgiven, endentured servants released and then all foreclosed homes were given back to the original families.
God established bankruptcy and the original Hope for Homeowners program.
How great is our God!
The scenario you bring out is if you are able to pay in any way shape or form can you default on your mortgage. A person is only as good as their word. Even if you have sworn to your own hurt. Even if paying it makes life uncomfortable.
If a professing believer is able to walk away from their contractual responsibilities, what does that communicate about the character of Christ? That he only said he died for our sins, but really won’t follow through. That he only said he’d be with us until the edge of the age, but will really drop us mid stream? Bearing the name “Christian” carries a lot of responsibility with it. We’re to be holy as he is holy. It’s bad enough dragging our family’s name down, but to dishonor him who only has done us good, that’s shameful.
If you’re going to live in your home, and raise your family there — then why does the home value matter? Home values only matter when you’re buying and selling. The rest of the time in between, you’re simply living in this space. Since you felt that it was fair to pay $X per month for the privilege of living in this space, the “new” underlying value of the home should not matter. I firmly feel a home is not an investment (unless its a rental property) — a home is a home.
If you can afford to pay your mortgage, you should. I’m not well versed, Biblically speaking, when it comes to the year of Jubilee and what not, but not paying a bill just because you can be forgiven of it in 7 years feels wrong. I can see why, financially, walking away from an underwater mortgage makes sense. But then wouldn’t it also make sense for your employer to stiff you on your paycheck or your customers to refuse to pay the money they owe you? Shouldn’t your tenants avoid paying as much rent as possible? Is pick pocketing and car jacking okay?
It of course depends on the situation. If continuing to pay a mortgage would negatively affect me in such a way that would make my life miserable, I would walk away.
– Not being able to send kids to collage
– Not being able to save for retirement
– Always living paycheck to paycheck
Walking away isn’t a “get out of jail free” card. There are pros and cons just like every other choice. If you choose to walk away, you are accepting the negative consequences.
“Collage”? Wow, I can’t spell today.
I think if you can afford to pay but don’t want to anymore, that it is bad. The house was worth $X to you when you signed the papers, and it’s not like the paperwork said “Pay only if your house maintains or increases in value.”
Many people with car loans are underwater on them…should they just walk away? I guess they could, but they’d be without a car!
If folks are willing to stay in their house for 10-15 years or so, perhaps the market will turn around enough so that they are at a break-even or better point. I know it’s a long wait for some, but you’ve gotta live somewhere, right?
I feel really bad for people in this situation. I’m not, because I’m a renter. I can’t say what I’d do if I did buy a house and was then massively upsidedown, but I think I’d stay with it unless we had a financial catastrophe that drained our emergency fund and we were having trouble putting food on the table.
Jamie J says
If our society based lending on a 7-year forgiveness cycle, our loans would look a lot differently.
I’m not a theologian, but I trust the basic logic God gave me. These tell me that society, as a whole, is better when people honor their word. Moreover, “strategic” foreclosures seem like covetous behavior, which isn’t good.
Derrik Hubbard, CFP says
I think that the best biblical principle that applies to this kind of situation is Psalm 37:21
“The wicked borrow and do not repay, but the righteous give generously;”
I would also say that we should be very careful to apply the year of Jubilee principles in the Old Testament to our modern practice of chapter 7 bankruptcy. The practice in the Old Testament allowed the holders of the debt to release the debtor, not the debtor to release THEMSELVES from the debt.
Bank Reviews says
I dont think the bible has anything to do with this! This is a government matter, and what we have learned for the past is to never cross government with religion. I respect you view but sorry not everyone is religious
1) walking away doesn’t mean the end of paying money to live somewhere. it just means paying rent instead of a mortgage.
2) walking away sucks, but the question of whether it is “okay” is irrelevant. people will walk if they feel it is in their best interests. honestly, I don’t see the real problem. the bank is supposed to structure the loan so that if the owner walks away, then they KEEP all of the equity the owner has built up (which includes a down payment), PLUS they sell the property. you heard it here first folks – banks make money when you walk away. banks that lent on 0% are the only ones getting burned by walk-aways, and honestly, they deserve it b/c only a fool would lend on 0%.
Track Your Bucks says
“Walking away” is a business decision. You are putting yourself and your family in a hopeless economic situation over a mortgage-induced guilt trip. Does the Bible advocate throwing good money after bad – in the form of paying on an underwater mortgage? Doing so must be in and of itself looked at as a morally bad decision. Your family needs to eat, enjoy life, and thrive. This can’t happen when you subject your family to the artificial boat anchor of the underwater mortgage. Besides, why is it morally bad? The bank comes in and gets control of your house – it loses nothing. You paid to live in that house while you were there. You didn’t get anything for free. It’s immoral to subject yourself to mortgage tyranny – and it’s immoral to denigrate those who “walk away” in pursuit of a better life.
Businesses change, cancel, and dispute contracts all day, every day. To somehow imply that individuals shouldn’t have the same power is not only immoral, it’s foolish.
MJ King says
Let’s say the situation is flipped. A house purchased for 200k is now worth 500k. Would that owner share the profits with the bank? I think not. Strategic default is a game of “heads I win, tails you lose”. Bad business and bad ethics.
No one is stopping you from sending profits to the bank.
I did not buy beyond my means. I put down 20% and have a conventional loan. I love my place.However, I planned to use this as part of my retirement which due to my age will not work out. The banks allowed others to buy when they understood them to be a high risk. Due to this fact it has sucked out all the equity of paying clients. Is it right to continue to pay on a place that it is not useful as retirement? Is it better to put that money toward a retirement plan that will work. With the state of our economy my kids won’t have the money to help support me. So..it is a very difficult decision. Any thoughts?
When the mortgage brokers had me convinced an equity loan and refinacing was the best thing to reduce my debt and I believed them enough to do it two times I can now without hesitation say that was pure bull, they were taking me for a commission and doing what was in their best interest not mine. If they had no moral compulsion to give me an honest loan or really look at my financial situation and give me a fair deal then neither do I. I guess its easy to believe in the moral imperative as long as it has not happened to you.
If you think the system was not gamed by those holding the keys then think again. If you think less regulation of lenders and the financial industry is a good idea then maybe one day you will feel the pain too in higher interest rates and excessive fees. There is no morality there, only cold hard business. But the industry can grease many palms so it must be alright.
peter – not sure what happened to you, but refinancing should save you money after a certain number of years.
in the end, folks, the rules of the game are the NO ONE, not God, not Jesus, not Buddha has YOUR interests as much in mind as YOU. thus, we need to do research, and NOT count on people who are earning commissions to tell us what to do. pay a financial advisor by the hour…free advice is always too expensive.
Gordon, if a person’s main objective is self-interest then we would have no soldiers in harm’s way because self-preservation and personal interests would demand otherwise. Instead a soldier risks his own life and willingly, if called upon, sheds his blood for the GREATER GOOD of the nation whose flag is on his arm. That’s how it works in the armed forces.
For housing, my plummeting housing prices (I’ve lost 55%) are due in part to self-interested buyers who only embrace commitment when the benefit in doing so lands in their kettle; otherwise they cut and run. Every time another weasel bolts, I sink a little lower. Strategic defaulters cost me, and all of us really because it creates economic uncertainty which begets downturn and ultimately recession. If too rampant, then economic collapse.
This country needs fewer people who proudly (to their shame) wave the flag of self-interest while living within a land of prosperity provided by our forebears whose blood calls out from the ground that commitment and the greater good tramples self-interest.
Phil – I’m sure that a lot of soldiers enlist for patriotic reasons, but many are doing it for the money. You may not believe me, but I personally know people who are in the forces because it would mean they get health insurance and other benefits.
Phil, I would encourage you to consider walking away if you are super behind. The bank made a calculation to profit off of your loan, and they took a downpayment as insurance IF you walk away. They make money if you walk away, so don’t NOT walk away just because of the bank, or because baby Jesus will get upset.
We bought our house about 9 years ago and watched the value go way up and then plummet. About 3 years ago, my husband went a year without a steady job and we had to negotiate a mortgage modification, which basically got us back on track with payments after not paying for several months. We’re at the point now where we are barely making enough to pay bills….there’s never enough for savings, college fund, vacations, etc. And now, the house (which is an older home) seems to be falling down around us. We simply can’t afford all the repairs….we’re looking at needing a new roof in a few years, and with this mortgage modification, the interest rate we’re paying on the mortgage will rise incrementally each year over the next several years.
Now, we’re 30-40% underwater so getting out of the house and into something more affordable is not an option. I want to do the right thing, but I’m nearing the end of my rope.