Nice segment from PBS about strategic defaults on mortgages (tip of the hat to Barry Ritholtz).
If you have been reading my blog, you know that I am all for a strategic default when it makes sense. Too many Americans have this view that it is immoral to walk away from a mortgage. These folks gulped down the banks kool-aid – Oh Yeah! Let’s follow this logically from the bank’s viewpoint. Defaulting on a mortgage means you break your word. A man is his word. Ergo, a man is his mortgage. Sounds kinda silly doesn’t it.
The reality is it is a business decision. A mortgage is a contract between the bank and borrower. It lays out the contractual obligations of both parties. If the borrower pays all principal and interest over the required term, the borrower receives a free and clear title to the home. If the borrower fails to make timely payments, the bank reclaims the home. Pretty clear.
Many will say that letting your home go to a short sale or foreclosure hurts your neighbors by driving real estate prices down. This is total bunk. It actually helps the market. How can that be? Let’s suppose that homes are artificially inflated and that the only homes for sale are non-distressed sales. These homes will not attract buyers due to the inflated prices. Even in a normal sale, the price will have to drop. It may take longer as the homeowner is anchored to the peak price, but it will happen. Foreclosures merely help the market find the happy medium between buyers and sellers at a quicker pace. This process brings liquidity to the market. It creates a normal real estate market as realtors, home inspectors, mortgage brokers, and home improvement specialists are employed.
The end of this clip features a banker who gives the usual argument, “why would banks lend to people if they believe people will walk away.” To that, I say why didn’t you do your job properly. Had the banks required folks to go through a proper underwriting procedure, we wouldn’t be in this mess. Had the banks ensured the homeowner could afford the home, we wouldn’t be in this mess. Had the banks required a downpayment commensurate with the risk they were undertaking, we wouldn’t be in this mess.
Why should the bank come out of this mess unscathed with the homeowner paying every cent of interest and principal? After all, the bank hires the appraiser for the home sale, AND they make the borrower pay for the appraiser. If the bank’s hired hand properly performed his or her job, we wouldn’t be in this mess.
If you are a homeowner who could rent for substantially below your mortgage for a similar property, and you are severely underwater by 20% or more, then you are a fool if you stay in your mortgage…unless you really plan to stay in the home forever, need a strong credit report due to your job (security clearance), or you have a built in trampoline (who could leave that, after all).
Get ready for more strategic defaults as the shame fades. Now, what is your opinion.