Baby Boomers: Strategic Default vs. Mortgage Morality
Are your real estate holdings underwater? Do you owe more on your mortgage than your property is worth? Struggling homeowners are under tremendous financial and emotional pressure due to the crash in the economy and real estate market. Our guest contributor, Paul Stevenson, a leading expert on strategic default, talks about what it is, the risks and how it could salvage your family’s financial future. He also clarifies the ‘mortgage morality’ mystery.
Strategic Default and Mortgage Morality – By: Paul Stevenson
It seems like every time I turn around I see or hear yet another commentator discussing how Strategic Default for their underwater mortgages is immoral. Furthermore, the growing trend of Strategic Default is deemed a sure sign that the apocalypse has finally arrived in our society.
There are of course other voices out there, including me, who are explaining things a different way, with the intent not to “stick it to the banks by encouraging people to walk away from their mortgages,” but instead to clarify the options for millions of Americans who are in fairly desperate situations that threaten their financial futures.
This work is necessary, because there has long been an asymmetry of information – the banks do not go out of their way to help underwater homeowners understand clearly and calmly the solutions that may be available to them, along with the risks and rewards involved. Furthermore, in the current crisis, by many accounts, the banks have not been overly helpful (or speedy) in implementing the government-created mortgage modification programs that are designed to help these homeowners.
Who is Right?
Unfortunately it’s not that simple, because it’s not really a matter of right and wrong. It’s a matter of perspective. If your perspective is the one that has long been propagated by the banks and the government, then you believe that you absolutely have a moral responsibility to pay your mortgage, no matter what. This long-held popular perspective effectively says that you have a responsibility that goes beyond the legal and financial agreement (the mortgage) that you signed with the bank.
I’m not saying this perspective is correct, I’m merely pointing out that this “additional layer of responsibility” has been present in most people’s minds for years. And it’s in the banking industry’s best interests to keep it there. Perhaps we could refer to it as a “Morality Premium” that has been applied to mortgages, though I cannot see any rational financial basis for it.
An analogy for the Morality Premium can be seen in the risk premium of, say, equity over debt. This equity risk premium is based on the rational financial principle of risk vs. reward – generally speaking equity is more risky than debt, so equity holders must be compensated at a premium in return for accepting this excess risk. Has the bank somehow done mortgage borrowers a favor, taking on excess risk beyond what it should have based purely on the financial facts of the transaction? If so, then the bank should expect to be compensated for this excess risk, which is where the hypothetical Morality Premium would come in. It seems odd that banks and other lenders – arguably the most meticulous businesses in the world – would leave the collection of this premium to depend on borrowers’ morality, rather than putting it into the extensive legal agreements that are required to complete a mortgage transaction.
We all know this isn’t the case. Banks evaluate the transaction in a completely rational manner and decide whether or not to enter into the mortgage, and what terms to require, without the thought of doing anyone any favors. In other words, they act exactly as they are required to act in order to uphold their fiduciary responsibility to their shareholders.
What Should the Borrowers Be Doing?
If the lenders are upholding their responsibility to their shareholders by extracting the most they can out of every mortgage transaction, then to whom is the borrower responsible?
The borrower is responsible to HIS SHAREHOLDERS – namely, himself and his family members, who all hope to have a financial future that is as solid as possible, within the confines of the law. In light of this, how is it that the borrower should be required to take on the extra moral responsibility to pay his mortgage, no matter what, when he isn’t being compensated for taking on this excess risk to his shareholders’ well being?
So What’s the Real Story?
The bottom line is that you do not have a moral obligation to pay your mortgage. You entered into an arms-length transaction with your lender in which both of you had competing interests and thus spelled out your obligations in a clear, signed contract. Unless the contract states that you have a “moral obligation to pay,” then it’s plain and simple – you don’t.
When you borrowed the money to buy the property, you entered into a business transaction. The lender evaluated the risks and concluded that it was a risk worth taking. For its protection, the lender also required you to pledge the house as collateral, as well as any equity you had in the house. The contract spelled out that if you don’t pay, the lender has the right to take the property and sell it before you get any of your equity back – if there were any equity left, which of course there is not if you’re underwater. The lender would not have loaned you the money if it had not concluded that doing so was a smart business decision. Your decision to enter into the transaction was also a business decision.
You decided to borrow the money and put at risk the property, your equity, and your credit rating. It’s obvious now, in retrospect, that both you and the lender made a bad decision. At this point the contract spells out what happens if you stop paying: the lender gets the property. If the lender intended for you to have a “moral obligation to pay,” it would have specified that in the contract.
While you may not think in terms of contracts and the terms for breaking them, I can assure that banks and all other large companies do. As such, large companies make the business decision to break contracts EVERY DAY. In this economic crisis, there have been many reports of large, profitable, cash-rich companies defaulting on multi-billion dollar property mortgages to large consortiums of banks – just because the housing projects they had mortgaged were far underwater, and they decided that it did not make business sense to continue paying. So the contract took over and dictated that the properties went back to the bank – and the companies walked away. And guess what? Those same banks will probably give those same companies mortgages again in the future – because it’s just business.
Where Does That Leave Underwater Homeowners?
It seems quite clear, then, that propagating the idea of the “Morality Premium” is the banks’ way of encouraging homeowners to do something that is not necessarily in those homeowners’ best interest, while lenders are doing what they have always done – maximizing profits without regard for questions of morality or social responsibility. If you are an underwater homeowner, you are in a position where you have to make the best financial decision you can for the sake of yourself and your family. No one wants to default on their debts, but at the same time, no one wants their children to be without food or shelter. These are difficult times that require difficult decisions.
Morality aside, there are other factors to consider. These include the economic and emotional costs of giving up your home and moving, the worry about the social stigma associated with defaulting, and the potential damage to your credit rating. Still, the sum of all these costs might turn out to be much less than what it would cost you – both emotionally and financially – to pay off your underwater mortgage.
There is No Guaranteed Free Lunch for Those Who Walk Away
The lack of a moral obligation to pay your mortgage does not necessarily mean that walking away is the right move for you. That depends on a number of factors, including the state in which you live as well as many other aspects of your personal and financial situation.
In many states, if you do not pay the mortgage in full, either through a foreclosure or some other form of walking away, the bank may be able to pursue a deficiency judgment against you. If successful, you may be liable to pay the difference between what you owe and the market value of the property the bank took back. The main idea for strategic defaulters is that the banks are not likely to pursue such a judgment, because they simply do not have the bandwidth due to the enormous volume of bad loans on their books. Thus far in the crisis, it seems that this has been a reasonable assumption to make.
Beyond the worry about a deficiency judgment, there may also be significant tax implications if the bank does forgive the balance of your mortgage. And of course your credit score is certain to suffer a significant drop. So clearly, if you walk away, there is no guarantee that you will be getting away “scot free.”
Strategic Default is a complex issue that must be understood thoroughly before you enter into it. However, if your analysis determines that it is not in your financial best interest to continue paying your mortgage, then I urge you not to let false beliefs about moral obligation put you and your family in further financial peril. If you want help learning more about Strategic Default, and whether or not it might be the right decision for your underwater mortgage, my Strategic Mortgage Default System will give you a clear, concise, and comprehensive picture of what your best option is.
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Paul Stevenson is an expert on strategic default and the creator of the Strategic Mortgage Default System http://www.strategicloandefault.com. This acclaimed program provides a clear, concise, and comprehensive analysis of the risks and rewards of strategic default, helping underwater homeowners and investors determine if strategic default is the right choice for their situation. Paul Stevenson’s work is dedicated to teaching property owners “Everything you need to know BEFORE you stop paying your mortgage.” Article Source: http://EzineArticles.com