Should You Walk Away from Home Debt?

For many underwater homeowners, walking away from their mortgage debt is the best financial decision; however, most will not walk away from their mortgages. Enough borrowers will default to make a steady stream of properties like today’s.

806 SILK TREE Irvine, CA 92606 kitchen

Irvine Home Address … 806 SILK TREE Irvine, CA 92606
Resale Home Price …… $459,000

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{book1}

From the lands lying at the end of World
I am bringing this dress as a gift, it is
Made with the purest silk
She smiled at me,
She never wore the dress
Touching the fabric was like holding
Nothing in your hand

The Silk Dilemma — Elvenking

Nothing in your hand; it is what underwater homedebtors have. They occupy a house — just like renters do — but most of them do so at a huge premium to renting. Underwater homedebtors have no equity; what they do have is the dream of equity in the future. They have a position in a financial market that most resembles an option contract that is out-of-the-money.

People who are underwater today and paying a premium are still hoping they will get a return on those premium dollars when their house value rises above their mortgage and puts them back in-the-money. Mostly this is based on fantasy or Zillow Zestimates or some other such nonsense, when in reality, their property values will likely decline further, and it will take much longer than they want for prices to come back. That is the way financial bubbles deflate.

Most people will not walk away. Most will continue to suffer in silence wait the decade or more for prices to recover. People become invested in the process. Once they have held on for two or three years too long, they feel committed to seeing it through, and many will. This was the experience of the early 90s, and since that bubble wasn’t near so massive, the market did recover in 8-10 years and life went on.

{book3}

The Great Housing Bubble was much, much larger than the bubble of the 90s, and we have not deflated back to stable price levels yet. Those that hang on will likely wait much longer than those who bought in the last bubble.

Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis

Brent T. White

Abstract

“Contrary to reports that homeowners are increasingly “walking away” from their mortgages, most homeowners continue to make their payments even when they are significantly underwater. This article suggests that most homeowners do not strategically default as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to induce homeowners to ignore market and legal norms under which strategic default might not only be a viable option, but also the wisest financial decision. Unlike lenders, individual homeowners have thus generally not acted to minimize their losses and have born a disproportionate share of the burden from the housing collapse.”

WalkingAway1029.pdf

From the main text:

“This article suggest that most underwater homeowners don’t default as a result of two emotional forces: 1) the desire to avoid the shame or guilt associated with foreclosure; and 2) fear over the perceived consequences of foreclosure – consequences that are in actuality much less severe than most homeowners have been led to believe. Moreover, fear, shame, and guilt are not mere “transaction costs” that homeowners calculate according to their own personal tolerance for each. Rather, these emotional constraints are actively cultivated by the government, the financial industry, and other social control agents in order to induce individual homeowners to act in ways that are against their own self interest, but which are – wrongly this article contends – argued to be socially beneficial.”

I totally agree with the observation made here. The powers-that-be are working in a coordinated effort to convince people to keep hanging on, not because it helps the borrower, but because it benefits the lender. The culmination of these efforts is a series of Bailouts and False Hopes.

“Unlike lenders who follow market norms, individual homeowners are encouraged to behave in accordance with social norms of “personal responsibility” and “promise-keeping.” Thus, individual homeowners tend to ignore market and legal norms under which
strategic default might not only be a viable option but also the wisest financial decision. As a result, individual homeowners have born a disproportionate share of the costs of the housing meltdown.”

When a borrower defaults at a bank, it is a tiny blip on some complicated financial statement of a large, faceless lender — the same lender that made a fortune putting the borrower into an unstable loan to begin with. Lenders made the problem, but they are trying, hoping, praying they can pass off the responsibility to everyone else — particularly underwater homeowners. It is the individual homeowners who bear the greatest burden and it is the borrowers who will pay the price through a decade of debt slavery with the feeble hope of appreciation to bait them on.

{book2}

IMO, this is where it gets even worse. For the whole system to hold together, kool aid intoxication must be sustained. If the underwater homeowners truly accepted the idea that prices may not come back in a reasonable time — and prices will never come back as quickly as homedebtors imagine — people will default in larger numbers.

In one of the more damning portions of the paper, Dr. White writes:

… social control agents such as the government, the media, and the financial industry use both moral suasion and disinformation to cultivate these emotional constraints in homeowners.

Is he a conspiracy-theory nutter, or is he an accurate observer of what is going on? I will let you decide.

Should You Walk Away?

I found a link to a site, Pay or Go. With a few simple inputs the site will tell you whether or not it is in your best interest financially to walk away. It also has a number of informative links to major newspaper articles on the subject.

The calculator on the site has an important note that drives to the heart of the problem: people believe house prices appreciate faster than they really do.

IS IT IN MY ECONOMIC INTEREST TO WALK AWAY?

You decide. This calculator is just a tool to help. Numerous variables are involved but the biggest is probably your assessment of the future of housing pricing. No one can predict future prices, but the conventional wisdom says that it is probably not realistic to believe that housing prices will increase by more than 4%-8% per year on average.

It seems obvious to me that one of problems people were having with this tool was that they put in assumptions for appreciation that are too aggressive. It is the same kind of thinking that inflated the bubble.

Faith in market kool aid is not enough. With a massive overhead inventory of those who want or need to get out at breakeven (including the lenders and their shadow inventory), no amount of wishful thinking is going to make prices rise. Timing Does Matter. Low interest rates may help cushion the blow, but peak prices are not right around the corner.

I am starting to believe that kool aid intoxication may never go away, particularly now that it is in the government’s best interest to keep it tasty and keep it flowing.

806 SILK TREE Irvine, CA 92606 kitchen

Irvine Home Address … 806 SILK TREE Irvine, CA 92606

Resale Home Price … $459,000

Income Requirement ……. $95,908
Downpayment Needed … $91,800
20% Down Conventional

Home Purchase Price … $650,000
Home Purchase Date …. 6/29/2007

Net Gain (Loss) ………. $(218,540)
Percent Change ………. -29.4%
Annual Appreciation … -13.7%

Mortgage Interest Rate ………. 5.08%
Monthly Mortgage Payment … $1,989
Monthly Cash Outlays ………… $2,800
Monthly Cost of Ownership … $2,300

Property Details for 806 SILK TREE Irvine, CA 92606

Beds 3
Baths 4 baths
Size 868 sq ft
($329 / sq ft)
Lot Size n/a
Year Built 2007
Days on Market 62
Listing Updated 11/7/2009
MLS Number 9405653
Property Type Condominium, Townhouse, Residential
Community Columbus Grove
Tract Oakp

According to the listing agent, this listing may be a pre-foreclosure or short sale.

A MUST SEE! 3BED+4BA+3CAR GARAGE W/WIDE OPEN VIEW IN PRIME LOCATION. HARD WOOD FLOORS & UPGRADED CARPET,GRANITE COUNTERS IN KITCHEN, GE PROFILE STAINLESS STEEL APPLIANCES,SPA,CLUB HOUSE, TENNIS CT. CITY LIGHTS, NEAR THE DISTRICT FOR ALL SHOPPING, DINING & ENTERTAINMENT,BIKING, RUN/WALK.

ALL CAPS

A MUST SEE! Wow! I am so motivated….

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I could have titled this post, “How to Lose a Fortune Quickly.” A 30% drop in just over 2 years is remarkable… documenting the transaction that began 5 months after I started warning buyers on the IHB… that is priceless.

34 thoughts on “Should You Walk Away from Home Debt?

  1. RogBoy

    Those figures for the floor area can’t be right, can they? 868 sq ft for 3 beds / 4 baths – do you have to sleep standing up?

  2. Dan in FL

    IR, a word of warning: DO NOT WALK AWAY BEFORE TALKING TO AN ATTORNEY IN YOUR AREA.

    The advise to just walk away works for some people, but not for others. States have different laws concerning housing debt. Some states are non-recourse states (many loans in CA are non-recourse). Other states, like Florida, are recourse states, meaning the bank can pursue you after the foreclosure for the deficiency.

    So I repeat: DO NOT WALK AWAY BEFORE TALKING TO AN ATTORNEY IN YOU AREA. Preferably one who is savy on foreclosure proceedings and debt collection law.

    1. CA

      I’m going to argue against this one for some buyers… if you’re savvy enough to know what kind of loan you’re in, there’s no need to consult with an attorney. I’ve had many friends strategically default, none of them consulted an attorney as they knew they had non-recourse loans.

      In fact, I knew more from my own research than the attorney that I spoke to prior to our strategic default. Needless to say we didn’t retain him.

      Most loans go through the non-judicial trustee sale process in CA simply because of the redemption period/costs associated with a judicial procedure. I’ve searched the dockets and rarely find any judicial foreclosure proceedings filed.

      It’s surprisingly easy to default…stop paying, turn off your phone, you’re good to go.

      1. Dan in FL

        In CA, a person who has educated themselves on the process should be fine.

        The problem is with people from outside CA assuming the rules are the same in their neck of the woods.

  3. AZDavidPhx

    OUCH!
    http://www.crackthecode.us/images/falling_knife.gif

    The denial flavored Kool-Aid is still flowing nicely.

    I was told over the weekend that prices have nowhere to go from here but UP. Of course, nobody can give a coherent reason as to why prices can only go up from here – apparently, house debtors can wield the power of magical thinking to put a floor under their declining equity.

    I was told that the jerk next door just up and left because he figured out that he could go and rent a nicer house down the street for cheaper than owning! GASP!

    Now his old unmaintained house sits out on the market dragging down everyone’s value in the neighborhood! Yes, that is it – this one Joe Blow single handedly brought down all the values in the metro area by walking away to go rent.

    SIGH – what a tragedy we have inflicted upon ourselves.

  4. AZDavidPhx

    I love this listing description. I give it a Realtor(C) Thumb’s Up stamp of disapproval.

    http://www.crackthecode.us/images/realtor2.jpg

    3BED+4BA+3CAR

    Clever use of the “+” character combined with the CAPS. Now the whole thing looks like one long jumble of unreadable SH_T.

    A MUST SEE!

    Crap filler statement? Why not say “AVOID – STAY AWAY”.

    GRANITE COUNTERS IN KITCHEN

    In the kitchen! AH, YES! Of course! Of course! That’s where these things go.

    TENNIS CT

    Tennis in Connecticut?

    RUN/WALK

    HUH? Random brainwashing commands.

  5. winstongator

    I take issue with the term ‘most’ that is peppered throughout the paper. Is ‘most’ closer to 51%, or 99%? You also need to weigh based on amount underwater. No one will strategic default 5% underwater, or possibly even 10%. What about those 50% (or more) underwater (100% financing 50% value drop)? Also the further underwater, the higher premium you’ll be paying relative to rent.

    Consider three identical homes next to each other. One rents for $2000, next bought in 2004 for $450k, the other bought in 2006 for $800k. What do you think will happen?

    What might keep the person with the $800k-price from strategic default is the fact that they might have the savings to eat the loss or negotiate some sort of short-sale. If they are completely stretched, I do not see many people keeping up with those payments. Few people in 2006 were conservative about DTI, so nearly everyone that bought then was stretching…in ‘good’ economic times…so a huge number are stretched now. Maybe that shows up in the paper as something else, but it is closely linked to being underwater.

  6. winstongator

    I don’t like the paper because of their example. I’ve looked at a lot of housing transactions in FL, and have not seen a price go from $585k to $187k. Their data is not same-home sales, but looking at averages for an area. Also their couple makes $167k/yr. Put them in a 50% gross DTI (closer to what people were actually doing), and you’d see a much different outcome than the author posits.

    I do like their conclusion that we should not make this a moral decision, it is a market failure.

  7. dafox

    what’re the chances that the current owner was one of those who camped out overnight to get into the condo buying lottery when this was built in 2007?
    All that effort to lose a hundred grand per year.

    1. IrvineRenter

      I wonder if the people who bought in the frenzy fully accept the totality of their failure? Losing $200,000 is a major reality check.

      1. winstongator

        Are the buyers really going to be the ones eating the $200k loss, or is the bank goign to get some indigestion too?

  8. lowrydr310

    I have a problem with the numbers again:

    Income Requirement ……. $95,908
    Downpayment Needed … $91,800

    Monthly Cash Outlays ………… $2,800

    First off, go find me someone in Southern California who earns $96K and has $91K saved up. There may be a few people, but realistically do you think that most people have this kind of savings?

    Second, $2800 a month? Perhaps that’s closely in line with rent for one of these homes, but that’s about half of the monthly take home pay on a salary of $96K. While I’m sure some people can handle that, it seems awfully dangerous as it leaves very little for other necessities especially if you have a family.

    Am I’m just too conservative with my finances?

    1. IrvineRenter

      “Am I’m just too conservative with my finances?”

      That really is the California Question, isn’t it? Lenders keep pushing the limits on DTIs, and borrowers keep bidding up prices. If you refuse to use a 50% DTI, you get left behind by lower wage earners who are willing to do so. You either live in a neighborhood with people making considerably less than you do, or you stretch like your cohorts and become a debt slave.

      1. Perspective

        “…You either live in a neighborhood with people making considerably less than you do, or you stretch like your cohorts and become a debt slave…”

        We’re in the former category. We bought a townhouse at 2.3x our income. The Mrs just bought a Land Rover, which feels a little out of place in our neighborhood; but that’s why we bought a house we could afford – so we could buy other things without increasing our debt.

        1. IrvineRenter

          I wonder what the neighbors would think if they knew you probably make double what they do? I commend you for being willing to live so frugally.

  9. Lee in Irvine

    Meanwhile the pressure on the banks continues:

    OC Shadow Inventory Expands, and 7.4% 90 days+ behind

    A troubling disparity is growing in Orange County’s housing market.

    Banks and loan servicers are holding few foreclosures. That’s somewhat good news, because it shows buyers are taking foreclosures off the market.

    The ratio of bank owned properties (REOs) against all outstanding first mortgages in Orange County has fallen steadily since August 2008. It dropped as low as 0.27% at the end of October 2009, reports First American CoreLogic. (REOs are the red columns in the chart below.)

    But the ratio of loans 90 days or more past due has increased every month for the past 43 months! (The chart to the right only goes back to 2007, but 90 day lates have been rising since early 2006). At the end of October the ratio hit a record 7.4%.

    The expanding gap between 90-day lates and REOs suggests a growing backlog of shadow inventory — homes that must some day be sold as short sales or foreclosures. (Of course some of those bad loans may be against properties listed for sale now.) In a short sale, a property is sold for less than debt owed to the bank.

    One reason for the rise in shadow inventory: all loan modification programs to date seem to have delayed more than prevented foreclosures.

    1. OC Progressive

      The growing delinquency rate is the real story here. State and federal moratoriums, as well as the inability of the lenders to process the mountain of delinquencies, has dramatically slowed the resolution of these problems.

      But they are only postponed.

    2. IrvineRenter

      Serious U.S. mortgage delinquencies rise

      WASHINGTON – Serious delinquencies among U.S. prime mortgages rose nearly 20 percent in the third quarter from the prior quarter, as the percentage of current and performing mortgages fell for the sixth consecutive quarter, banking regulators said on Monday.

      The report by the Office of Comptroller of the Currency and the Office of Thrift Supervision, which are part of the Treasury Department, covered about two-thirds of all U.S. mortgages.

      It found 3.6 percent of prime mortgages — those made to the most credit-worthy borrowers — were seriously delinquent in the third quarter. That was more than double the year-ago quarter and up nearly 20 percent from the 2009 second quarter.

      The report defined “serious delinquencies” as those loans 60 days or more past due and loans to delinquent bankrupt borrowers.

      Big U.S. banks and thrifts carried out 2.4 million home loan modifications, trial period plans or payment plans in the quarter, spurred mostly by a government plan offered by President Barack Obama, according to the report.

      Most came from the government’s Home Affordable Modification Program. Mortgage servicers carried out 274,000 trial plans in the third quarter, up 240 percent from the second quarter when the plan was launched.

      But only 1 percent of those had been converted to permanent modifications as of September 30, 2009, the report said.

      A major cause of this disconnect is that loan servicers are finding that many borrowers who initially appear to qualify for the program do not, according to the report.

      The Treasury Department has been pressuring lenders and mortgage servicers to do more to ease the harm from rising foreclosures.

      Loan modifications made outside the new aid program fell in the third quarter by nearly 8 percent, the report said.

  10. IrvineRenter

    Luxury Homeowners in U.S. Use ‘Short Sales’ as Defaults Rise

    (Bloomberg) — Homeowners with mortgages of more than $1 million are defaulting at almost twice the U.S. rate and some are turning to so-called short sales to unload properties as stock-market losses and pay cuts squeeze wealthy borrowers.

    “The rich aren’t as rich as they used to be,” said Alex Rodriguez, a Miami real estate agent with JM Group USA Inc., whose listings include a $2.9 million property marketed as a short sale because the price is less than the mortgage, leaving the bank with a loss. “People have reached the point where they can’t afford the carrying expenses of a $2 million home.”

    Payments on about 12 percent of mortgages exceeding $1 million were 90 days or more overdue in September, compared with 6.3 percent on loans less than $250,000 and 7.4 percent on all U.S. mortgages, according to data from First American CoreLogic Inc., a Santa Ana, California-based research firm. The rate for mortgages above $1 million was 4.7 percent a year earlier.

    As defaults on the biggest mortgages rise, borrowers such as Steve Holzknecht are turning to short sales to exit loans that now are larger than the market value of the house. In such a transaction, the lender agrees to accept less than a 100 percent payoff on a mortgage to expedite the property’s sale.

  11. newbie2008

    “Pay or leave”
    That’s only 2 of the 3 options.
    With the new FHA extension of the subprime loan market of only 3.5% down. The 3rd option becomes sweeter. Buy a house at inflated price with a 3.5% down and $8000 tax credit.

    Live rent free for a year to two years!

    Run/Don’t walk to your nearest RE to buy an overpriced property.

    Consult a trustworthy and knowledgable local attorney on the law and local practice deciding.

    IrvineRenter,
    How much downpayment did the victim put down?

    1. zubs

      I heard the mortgage brokers are now tied to the mortgages they broker, so if a buyer defaults on a mortgage, the mortgage broker involved is put on a blacklist by the lender.

      Is that true?

      This info was given to me by a mortgage broker relative.

  12. ElricSeven

    They should call HAMP something different like, Homes Unaffordable Modification Program, or HUMP, since it results in payments that still can’t be made. And, it props up prices keeping renters out of the market. And, finally, because we all feel the effects of the government HUMP.

  13. Soylent Green Is People

    This is an FHA purchase and not a 20% down transaction. The 20 percenters are buying SFD’s, leaving the Condo market to the FHA buyers.

    So…. if you have a recourse loan…. is a bank in this market really going to come after you? Do we “know” this by experience (please comment) or “know” this anecdotally?

    My .02c

    Soylent Green Is People

    1. matt138

      If you don’t have a pot to piss in, who cares?

      I guess if you had some assets and felt like taking the risk of hiding them from a federally insured institution and getting popped for it… what kind of white collar prison resort sentence would you get?

      Now that’s rent free living!

    2. newbie2008

      I’ve seen SFU go through FHA with 3.5% down.
      As for a recouse loans, they are usually the second non-purchase loan in CA. The first usually does a trustee sale for the FC. The second is wiped off the title, but can go after the borrower. You can get blood from a stone, but can get some cash even from someone “without funds.” 3 months later, they get a call demanding the full amount of the second. Finally after a few weeks, less than 25 cent on the dollar was agreed on on one case and with payment over a few years. I not think there was any interest. The second did not play hard-ball, borrow had another house that could be counted as asset and was likely listed on the application. Most people don’t want to talk about it — both borrowers and the banks.

      The second can also not approve a short sale unless the first and borrow reduce their loss — a bird in the hand is worth two in the bush.

      Hopeless Apparitions & Mindless Phantasms : What the taxpayers’ money go bye-bye

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