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Doing the ‘Right’ Thing – A Topic That Will Not Die

By JLP | November 16, 2009

Just watched this video clip on Larry Winget’s facebook page:

Regardless of what the guy does, he’s in deep doo doo. He paid $340,000 (financing $272,000) for a house that is now worth between $120,000 and $140,000. He can afford the payment but is still thinking about walking away since the purchase is no longer in his favor. I wish I had more details regarding his situation but I don’t. That one advisor who talks about the after-tax cost of the mortgage makes some sense in that the true cost of the mortgage is less than this guy thinks it is.

Still, using a current value for the house of $140,000, at a 3% appreciation rate, it would take 30 years for the house to appreciate back to the purchase price. An appreciation rate of 5% would take 18 years. Bottom line: this guy’s going to be underwater for a long time.

Topics: Mortgages | 30 Comments »


30 Responses to “Doing the ‘Right’ Thing – A Topic That Will Not Die”

  1. BG Says:
    November 16th, 2009 at 1:10 pm

    If he could walk away, in-the-clear, then that would be best for him financially. Why pay all that extra money for nothing. The bank would be eating the loss.

    But, for him to walk away, wouldn’t he need to declare bankruptcy? Don’t you still owe the bank the difference for what they auction it off for, and what you still owe?

  2. JT Says:
    November 16th, 2009 at 1:33 pm

    BG,

    I’m not a bankruptcy lawyer but I do not believe you need to declare bankruptcy to walk away. It’s my understanding that you just stop paying. The bank will send threatening letters at first and then a notice of default. After a while they will foreclose and repossess the property at which point you will be evicted.

    As for what you owe the bank after foreclosure, that depends on the state. Some states are recourse and some are non-recourse. In recourse states you can be required to pay the difference or pay taxes on the difference. However, from my understanding it is also unlikely that the bank will file suit against you due to the cost of the litigation.

    On Mish’s website he gives a lot of good advice.

  3. Investing 101 Says:
    November 16th, 2009 at 3:44 pm

    I’m not an expert on the subject matter either but does it really matter if it’s a recourse state or not? My understanding is that if the bank eats up the loan, then this is a debt that you’re forgiven. So on a federal level wouldn’t you be required to pay taxes on the forgiven amount? I know for a fact that this is how it works for debt settlements. No idea what’s applicable when you walk away from a debt. Anyone care to elaborate?

  4. BG Says:
    November 16th, 2009 at 4:13 pm

    #3) Sounds like if you are in a “recourse” state, then the bank can sue you for the losses, perhaps even years after the fact…

    So, if the guy in the video is in one of those states — he is much better off staying in his house, otherwise the bank will dump the property at auction, and sue him personally for the difference.

  5. BG Says:
    November 16th, 2009 at 4:16 pm

    Just checked, Nevada is a “recourse” state — so he’s screwed — he can’t just walk-away and expect everything will be fine. With the large loss $200k, the bank will come after him most likely.

  6. Money Funk Says:
    November 17th, 2009 at 11:47 am

    I just learned about banks suing walkaway home owner for deficiencly claims. CA and FL prohibit them, but for other states it could cost the former home owner lots of money.

    It’s sad to see walking away from your home as a norm of society.

    A friend’s neighbor participated in a new program where the bank will pay the delinquent homeowner to hand over the keys and walk away. (Tried to search on internet, but couldn’t find). It’s a huge 6 bedroom house now going for $270K. The previous home owners bought it at $560K. My husband and I thought real hard about snagging it, but we are sticking to our original plans.

  7. JT Says:
    November 17th, 2009 at 11:54 am

    He’s not totally screwed. I believe he can still file for bankruptcy which would discharge the money he owes to the bank after foreclosure. Once again, I’m not a lawyer so don’t take what I say as advice.

    Like Mish says, consult an attorney before doing anything.

    If it makes sense to walk away then do it. Don’t let the government use fear tactics to keep you a debt slave. Make the correct decision that will best protect your family.

  8. Lord Says:
    November 17th, 2009 at 2:46 pm

    If he was in a non-recourse state he should have done it when it wasn’t taxable (2007-8). Now he would have to pay taxes on it even if the bank couldn’t come after him. If he is prepared to declare bankruptcy he might proceed but if he can afford it, it won’t get him off. About the best he could do is bide his time until it became necessary to sell regardless and let it go then (unemployed, transferred, disaster, disability, etc.). The bank would likely have to eat it then and bankruptcy would be more possible.

  9. Johnnyd Says:
    November 18th, 2009 at 4:51 pm

    Great blog http://allfinancialmatters.com/ keep it up

  10. ANDREW Says:
    November 18th, 2009 at 5:57 pm

    He could look into a short sale, but if he is current, the bank will be unwilling. It is better than a foreclosure and lawsuit, though.

  11. Kirk Kinder Says:
    November 18th, 2009 at 9:17 pm

    He needs to walk away in one way or another (short sale, foreclosure, bankruptcy). He should see a real estate lawyer. But, I doubt the banks will come after the deficit.

    Also, I think we need to get out of this “immoral” push. Certainly, we don’t want to arbitrarily break contracts, but the banks push this guilt complex in hopes that it keeps people paying mortgages. In business, contracts are altered or broken all the time when the numbers don’t work. The bank is putting up 80-100% of the money for a home. They send “their” appraiser to value the home. They make the homeowner pay for this appraiser. So shouldn’t they eat it a bit for trusting the valuation of their appraiser.

    Besides, I don’t think the banks have been the most moral characters in this entire mess. So the banks who made a bad loan and didn’t do their due diligence should get repaid every cent while this poor sap spends his entire life paying for this house with nothing to show for it at the end after you factor in inflation. He would be much better letting the house go and buying one in a few years after his credit is repaired.

  12. Hogan Says:
    November 18th, 2009 at 11:34 pm

    Nevada is a recourse state but he will just declare bankruptcy. I have mixed feelings about walking away from your mortgage. I have a friend in Phoenix who is walking away from his mortgage because it is worth 100k less than what he bought it for in 2007 which is about 18 months after the market cratered down there. He most certainly can afford it so he is basically dumping in on the shareholders of the bank or the US taxpayer. Partners in crime the subprime borrowers and the bankers who knew better. Now we are all paying the price.

  13. ANDREW Says:
    November 19th, 2009 at 10:55 am

    The borrower and the lender do not share risk equitably. Only in the rare case that the cost of a bank’s funds is greater than the interest on loans, can a bank lose money without a borrower defaulting on a contract.
    If the borrower upholds the contract, the bank has a nearly garaunteed return.
    The Borrower, on the other hand, stands to gain if the house appreciates more than he/she pays in interest and mortgage costs, and stands to lose if the house depreciates.

    This system is inherently inequitable. You know that, however, before you sign up for a mortgage in good faith. Yes, this system sucks for you. If you don’t like it, then pay cash. I don’t like the idea of signing a contract, knowing that I intend to default if the market tanks.

    Islamic economics attempts to the inequity inherent in interest-based banking by saddling the bank with more of the risk.

    It would be interesting for JLP to do a post on Islamic finance.

  14. BG Says:
    November 19th, 2009 at 11:08 am

    #13) I thought Islamic countries are heavily in favor of the banks. The banks can have warrants served for your arrest if you fail to make loan payments, hence, extorting the money from the “victims” family members.

    JP did do a post on this topic:

    http://allfinancialmatters.com/2009/11/03/liz-pulliam-weston-debt-and-you-think-youve-got-it-bad/

  15. Ashley Says:
    November 19th, 2009 at 3:12 pm

    Very sticky situation. Something that goes ignored is that the banks, in a lot of situations, weren’t doing the “right” thing by shady loans and now by increasing interest rates at astronomical rates while they still can and getting over on customers through fees. Yet, I’ll still end it with two wrongs don’t make a right.

  16. Jim Says:
    November 19th, 2009 at 5:29 pm

    You should do the ‘right thing’ until it is impractical for you to do so. At some point if you are too far in debt then you simply need to declare bankruptcy. Having a house that is substantially underwater is a liability and a debt. This guy is about $130k in the hole on the house. Unless he has significantly more assets than that he is insolvent and bankruptcy should be considered. Theres no sense in trying to dig yourself out of a giant financial hole if its not likely you’ll ever do so. I’d try a short sale first, but the bank probably won’t like that idea. So unless this guy has a very high income and/or large assets he should probably walk away from the house. If the bank goes after him then he should declare bankruptcy.

    If the bank was insolvent without sufficient revenue then they would declare bankruptcy. So don’t feel too sorry for the bank cause they’d do the same thing if the shoe was on the other foot.

    Unfortunately yes its true that society as a whole is going to pay the costs for this, but you can’t expect one guy to shoulder unbearable debt due to misplaced morals.

  17. ANDREW Says:
    November 20th, 2009 at 10:03 am

    Assets don’t determine solvency. Cash inflows/ income does. JLP said he doesn’t have trouble making the payments. He is also, therefore, by definition, not bankrupt.
    It would be the same as having a bunch of credit card debt and nothing to show for it. If you can pay on it and your debt:income ratio (not debt:assets) does not pass a bankrupcy threshhold, then they will dismiss a bankrupcy.

  18. Don@moneyreasons.com Says:
    November 23rd, 2009 at 6:28 pm

    Hmmm, the guy doesn’t need to walk away from the mortgage. It sounds like he can still afford it.

    Perhaps he should at least wait a few years before even thinking about doing this. After all, maybe the area does pop back up. After all, there was a reason that he spent that much money on the house, right?

    The sad thing is a lot of people that are well off are doing this “stategic default” technique. See the linked msn article. Sad that in these times, people who are well off are taking advantage of the system too.

  19. JT Says:
    November 24th, 2009 at 12:29 pm

    Don,

    Why should he wait a few years? Because you say the area may “pop back up”? And what happens if it doesn’t? I’d be much more willing to bet that latter.

    I don’t understand why people think strategic defaulting is somehow screwing over everybody else. What about all the people that sold at the market top? After all, for every buyer there is a seller. There were plenty of people who sold at the top and took huge profits for doing nothing other than having good timing. Maybe we should claw back some of their money since they are “taking advantage of the system”.

    The point is people need to stop demonizing others who choose to walk away. They are doing what’s best for their family and I applaud and encourage them to do so. Some will say that walking away sticks the taxpayer with the bill in the end. They would be correct too. But if you don’t like that then you should be calling you congresspeople and yelling at them. Or better yet, voting their butts out!

    I will never understand why these people can keep getting re-elected year after year. If you voted for the incumbent in your state, and they supported the TARP funding, then you are just as much to blame as the congressperson who did the voting.

  20. ANDREW Says:
    November 25th, 2009 at 7:59 am

    Walking away from a mortgage shorts the bank, who then gets the money from someone else through interest and fees. You can only collect from those willing to pay. That is why credit card interest rates are so high. People have nothing to lose when they default on unsecured debt, so they do it readily.
    Then the rest complain that their rates were jacked up when they had been paying dependably.

  21. JT Says:
    November 25th, 2009 at 3:55 pm

    ANDREW,

    Yes, but you’re looking at the symptoms, not the problem. Take a step back and ask yourself why the person walked away from the mortgage to begin with. The common reason today is that housing prices were inflated. And how did the get inflated? Interest rates that were TOO LOW for far too long.

    The low rates pushed up the nominal price of housing which, in turn, required the person to take out a large mortgage. Normally the person wouldn’t qualify for such a large mortgage so the banks and underwriters played games with the numbers to make it all “work”. This led to Alt-A and Option-ARMs.

    So who was it that set the rates too low? Well, banks, for one. But they derive their numbers based on the rate set by the FOMC, otherwise known as the Fed. If there’s one thing that everyone should learn from this entire debacle is that it is completely foolish to let central banks try to set the interest rates. The market should decide, not the “independent” Federal Reserve which is anything but independent.

  22. ANDREW Says:
    November 25th, 2009 at 6:05 pm

    I agree with the steps in your logic.
    My problem comes at the point where you said people were required to take out large mortgages.

    Yes, ignorant people were screwed by Alt-A’s. Smart, responsible people need to operate within conservative debt:income ratio’s. What this implies is that I need to buy a smaller house when the market is up. I need to compensate for the low interest rate-induced bubble.

    My main point with my unpopular moral argument is that when I do sit down with a banker, if he asks me what I will do if the market tanks, I am unwilling to lie.
    If I answered honestly and told him that I would walk away, he would not loan me the money.
    I will not take out a mortgage knowing that I would break the contract due to inconvenience.

    When you speculate on housing, you gamble with debt. If I choose to make this choice, it will be with a committment to take my losses.

    Until then, I am renting.

  23. basicmoneytips Says:
    November 26th, 2009 at 8:36 am

    This is an interesting topic. Personally, I do not believe it is morally right to simply stop paying and let it go back to the bank. If you bought a stock and it dropped like this, you sell it and take the loss. The issue is that it is not his money but morally it certainly is.

    I would say stick it out and hope that values improve somewhat and sell in a few years, or sell now and take the loss. Don’t simply walk away, that is teaching people a very bad lesson.

  24. JT Says:
    November 30th, 2009 at 4:28 pm

    ANDREW,

    Thanks for the response. I certainly respect your opinion and applaud your honesty. I think the world needs more people like you.

    basicmoneytips,

    It’s easy to say stick it out when you’re not the one that owes $50,000 – $100,000 more on your house than it is worth. Would YOU be willing to throw $50,000 down the drain so carelessly? I highly doubt it.

    And your analogy to buying stocks isn’t quite right. It would be more closely related to buying stock on margin. In that case, if the stock drops, you are REQUIRED to sell (ie margin call) or deposit more money into the margin account. Unfortunately the real estate industry doesn’t work that way.

  25. ANDREW Says:
    December 2nd, 2009 at 8:47 am

    My mother paid 260000 on a 60000 mortgage by paying the minimum payment for 30 years. The interest rate was 8 percent. Paying more for a house than its market value is the norm.

  26. Steve Says:
    December 7th, 2009 at 6:02 am

    I think many people aren’t considering many other factors when using the moral imperative to pay back the loan.

    1. What caused such a dramatic drop? Most likely he was in an area that was highly speculated, so most of the homes are in foreclosure. Areas that have high forclosure rates are going to have higher crime rates, lower quality schools (if any still exist), etc. If that is the case, the safety and security of the homeowner’s family is a consideration. Would you want your children living in a neighborhood full of meth-heads and squatters?

    2. The contract is between both parties. This means that either party can “break” the contract when the finances no longer make sense. Both parties, the bank and the borrower, both know this risk when entering into the contract. The banks usually account for this within their interest structure, but we have an unusually high number of foreclosures which is way outside the normal limits.

    3. The bubble in the housing market is unprecidented (at least this big of a bubble), so we really do not know the length of time for the bubble to bottom out and correct, let alone attain normal gains. For all we know, that house will not bottom out in price for many years, and the original purchase price may not be seen during the borrowers lifetime. So, the time delta for recouperation of cost is unknown. Foreclosure will stay on credit for 7 years, so that is know. I would take a known time limit over the unknown in an investment of that size.

    Do people have an ethical responsibility to pay back debt? Yes, but just like any other ethical question all conditions must be considered. Even that news piece only gives us a partial insite to the entire situation, and sometimes the entire situation would suggest that walking away would be the most ethical thing to do for all people involved.

  27. Larry Winget Says:
    December 8th, 2009 at 2:20 pm

    I know this has been up for a little while but I just noticed it. The responses here are amazing. How can anyone say that you should do the right thing UNTIL or you should do the right thing BUT or you should do the right thing HOWEVER???????? You should do the right thing PERIOD. This is reason we have a problem in our society. Most of these responses about the conditions and fault and blame just sadden me and don’t make me very optimistic about the future of our society.

  28. justajerk Says:
    December 8th, 2009 at 8:27 pm

    Larry Winget: “This is reason we have a problem in our society.”

    Apparently, incompetent English grammar is killing our society too. Spell check much?

  29. Steve Says:
    December 10th, 2009 at 3:49 pm

    @Larry:

    If you are making references to my post, it’s not that I say you should do the right thing UNTIL something occurs, but that when conditions change, the “right thing” also changes.

    For example, the “right thing” to do is to tell the truth. However, if I am at home with an African American friend and two people dressed in KKK sheets with a torch knock on the door and ask if I have any “coloreds” at my house, the “right thing” to do is to lie, as the conditions have changed and I know what the result of telling the truth would do.

    This is my point on my post. In general, to pay your debt obligations is the right thing to do. However, the conditions here are so extreme that the cost to the family, such as safety, educational systems, etc. may determine that the right thing is to walk away.

    I am not suggesting that people should not try to do the right thing. We should look well beyond the simplistic notion of something should always be done a certain way and consider all options when we determine what the right thing to do is.

  30. Bill Says:
    December 28th, 2009 at 6:37 pm

    A mortgage is a contract between a borrower and a bank. Any and all consequences of breaking that contract are stipulated in the contract and in the laws of the state. In most states primary mortgages are non-recourse. So the bank gets to take the house but can’t come after any other assets. The bank knew this long before they wrote the mortgage. The bank approved an appraiser who appraised the house at the inflated value. The bank (if it was large enough) probably had several economists/housing market analysts on their payroll to assess the probability and consequences of a housing market downturn. The bank determined the required downpayment or set the requirement for the borrower to carry PMI to minimize the bank’s own risk. After all this the bank wrote the mortgage anyway.

    This has nothing to do with morality. We aren’t talking about no-interest loans between friends here. The bank made an investment and they (really meaning the unfortunate party who bought the mortgage backed security) lost their shirt on it. The borrower is obligated to fulfill the terms of the contract and abide by the relevant laws of the state. One of those terms/laws states that he can let the bank take the house in lieu of all future payments. It doesn’t matter that that isn’t the most profitable arrangement for the bank. Its a legal and perfectly reasonable option for a borrower to take given their financial situation. Its purely business. If it was me I wouldn’t even be embarassed by it. I’d have no issues telling my friends, family, clergy, the media, whoever.

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