On Sunday our pastor decided to preach about the dismal state of the economy and how we should react to it. During the sermon, he mentioned that his brother's house is worth fifty percent of what it was purchased for and that his brother has no choice but to walk away from his home. Now, our pastor's brother is self-employed, and I don't know his specific set of circumstances; if he can no longer make the house payments on his house due to loss of income he may, in fact, have no choice but to walk away from a home he can't sell. But more and more, we are hearing that if our houses have lost value we should just "walk away" from what has turned out to be a bad investment.
One vocal proponent of "walking away" is financial guru Suze Orman who has been quoted in numerous articles stating that those who are "underwater" in their mortgages should walk off and let the houses get foreclosed on. This past Monday, Ms. Orman appeared on "The View" with what has become her new rallying cry, "If you are upside down in your mortgage and the bank will not work with you, walk away from the house."
In Orman's book The Money Class, she advises borrowers, "Do the calculations everybody. How much is it costing you to actually stay in that house? How many years will it take for you to pay more for that house than it is worth? If it's 3 years, 4 years, 5 years, are you kidding me? That's a house you really need to say bye bye. It's not worth the money." Orman advises people who are upside down in their home mortgages to try to get the bank to modify the loan. Failing that, she says that homeowners should seek out a short sale or a deed in lieu of foreclosure. "If they won't do that, then walk away. It's just how it is."
The fact that a respected money expert is telling American borrowers that they can and should default on their loan obligations when they have the ability to repay is really a sign of just how far we have fallen as a nation. It is deplorable to think that we have come to a place as a society where defaulting on our obligations is considered some kind of a moral high road.
CBS Sacramento carried a story on April 28, 2011 of borrowers who did just as Orman suggests and let their homes go into foreclosure because they no longer have the equity they once did. Mary Beth and Bob Stucky were underwater $200,000 and the bank refused to reduce the principal, so they walked away and became renters. They are now renting a larger house for a smaller payment, and although they may not be able to buy a home again for many years, they say they feel "peaceful" because they realize that their home was a "bad investment." CBS Sacramento also interviewed Rob Sorenson who walked away from his home and allowed it to go into foreclosure. All of his credit had previously been good, but his decision to allow his home to be foreclosed on resulted in his having all of his credit cards cancelled so that when his dog got sick and had to go to the vet he had actually had to borrow $2000.00 from a family member since he does not have any access to credit. So he has not only defaulted on a major obligation, but he has actually become a burden to family members who are having to loan him money that he used to be able to borrow on his own.
Other than the nuisance factor, what is really wrong with walking away from a home that is underwater? Plenty. For one thing, it doesn't make any sense. If you have a fixed rate, fully amortized mortgage for thirty years, or fifteen years, or twenty years, you know at the time that you sign the mortgage documents how much your monthly payment will be and also how much you will be paying for that home. The truth in lending document included in every mortgage package contains the exact dollar amount you can expect to pay for that loan over the life of your mortgage, and it is normally two to three times higher than the amount you borrowed due to interest and finance charges. So in that sense, every mortgage holder is upside down on his or her mortgage when they sign the papers. But if you have not suffered a job loss, a health crisis, or a financial tragedy, you have no reason not to make those payments. Why? Because the appreciation or depreciation on the house is just a number that changes arbitrarily. When properties were appreciating at a skyrocketing pace, no homeowner ever went back to their mortgage company and said, "I know I bought this house for $200,000 and I financed $150,000 but now it is worth $500,000.00 so I think I owe you some additional money." So why, in the reverse situation, should the bank lower your principal simply because the value has dropped? You didn't owe them more when the values were rising, and you don't owe them less now.
If we had no moral obligation to pay for things that depreciated, no one would ever make a car payment again. Virtually everyone understands that the moment they drive their car off the lot, it has less value than it did twenty minutes before when it was sitting on the lot. If we applied the same logic to all items as we do to homes, we could not have any credit system at all since the moment that something became old or worn we would no longer need to make the payments. The problem with housing is that we no longer look at our homes as a place to live. We have decided as a society that our houses are supposed to contain enough equity to pay for our summer vacations and to give us a credit card to spend on whatever we wish during the year. If the house can no longer be a source of free fun money, it has failed us and we should not have to pay for it.
Second, the boom was artificial, and so is the bust. When real estate values were booming, we all seemed to forget the basic principles of gravity "What goes up must come down." Right now we are in a double dip, and values are dropping this summer and will continue to drop for a while as underwriting guidelines continue to tighten. But, after that, we can look for values to rise again as properties become more expensive. That house that today is worth $200,000 less than it was 4 years ago may have regained its losses in 5 to 10 years. In any event, when you walk away from a home you are making the payments on, you are throwing away all of the money you have already put into that home, which is ridiculous.
Third, although some people are forced into foreclosure by financial circumstances, many have other options. Most borrowers who are practicing strategic defaults have high credit scores and have not suffered a job loss. They simply do not see the value in making their payments. If you want to move into a cheaper house fine--how about renting your current home to someone else? As more and more people are forced to become renters, the demand for rental housing is going to grow. For a little effort, you can save your property and your credit.
Fourth, odds are very good that the house you are walking away from today may well be your last. As underwriting guidelines continue to tighten, many homeowners who have abandoned their homes for no reason are going to be shut out of homeownership in the future, either by much higher interest rates and financing costs, or by credit guidelines that do not give them a second chance. And Orman actually knows this. She says that the new American dream may not include ever owning a home again. "And if you do rent for the rest of your life, it's not a big deal. Who cares? Just invest that money you would've put in your home somewhere else....The new American dream really is a dream that allows you to sleep at night where you feel secure, and you know what is yours cannot be taken away again, because of the actions of others."
That's just nonsense. Orman acts as if strategic defaulters go off to a happy paradise with no more problems. Renters make the payments on properties that other people own and put wealth in the pockets of property owners--period. And while "what is yours cannot be taken away again" what is not yours certainly can be. Your landlord can lose the house you are renting to foreclosure if he does not make the payments regardless of whether you are making your payments to him or not. Or you can find yourself in the same situation as a woman who recently called me to tell me that her landlord is not renewing her lease because the landlord has decided to give her house to her own son and evict the tenant. Life does not come with guarantees, whether you rent or own.
Finally, homeownership provides security for people in their senior years. While young couples in their thirties and forties may not feel the pinch of renting, older Americans have typically relied on having their homes paid off as part of their retirement. A home that is paid off is good security towards any financial crisis, and many communities now protect seniors against out of control property taxes. Reverse mortgages provide seniors with the option of using the equity in their homes to offset living costs or to get rid of a mortgage payment that is too high. A home that is owned free and clear provides a senior with many options that a renter simply will never experience.
Orman is pushing all of those unhappy homeowners out there to hurry up and default sooner rather than later since the federal tax break for foreclosures and short sales will expire at the end of 2012. That would mean that if you default on $100,000 debt in 2013, you owe federal income taxes on $100,000. So in addition to ruining your credit and your future homeownership chances, you will owe a massive tax penalty to the IRS.
If you have lost your job, experienced a divorce resulting in loss of income, or gone through some other life changing experience beyond your control that has cost you your home, don't beat yourself up. Life happens. But if you are considering strategic default because your home is not worth what it used to be, don't be fooled by this concept that you are going to be better off "letting the house go." In the end, you will be better off if you act responsibly and meet your obligations--either by continuing to make the payments or finding a tenant who can make them for you. A few years down the road, when values have recovered and houses are very difficult to purchase, you will be glad you held on to your property.
