WatchWhy isn't everyone underwater on their mortgage strategically defaulting?
1. It takes the average foreclosure 600 days to complete. Rounding, lets call it 2 years. (Source: http://allfinancialmatters.com/2011/12/02/the-average-foreclosure-length-631-days/)
2. By definition of being underwater, the owners have no equity left.
3. Median price of a home in '07 was $247,900 (Source: http://www.census.gov/const/uspriceann.pdf).
4. Assume they had a prime loan, for some reason, @ 5% (Source: http://www.bankrate.com/funnel/graph/default.aspx?cat=2&ids=1,-1&state=zz&d=1825&t=MSLine&eco=-1) with 20% down ($49,580).
5. Their monthly mortgage payment is ~$1,0000.
6. After the 2 years, they would have accumulated $24,000 in cash savings. Not to mention not paying for insurance & maintenance. (I assume you have to pay taxes still or face prison time?)
Why the heck wouldn't you default and squat? Am I missing something?
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because some people have self respect and live up to their obligations
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San Francisco, CA
theoakman says
I get that from a civilized, good person standpoint, but rationally, that makes no sense.
Banks aren't going to forgive loans, why should people keep paying ones that are not to their advantage.
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Obama has created so many obstacles to prevent banks from foreclosure and encouraged people who can’t afford the house to either squat or modify the mortgage. Strategically defaulter would look like a fool compared to squatters.
http://ochousingnews.com/news/ravings-of-an-entitled-whiner-struggling-to-keep-a-home-she-cant-afford
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Some people have businesses and lines of credit. A default will trigger all kinds of things such as a huge jump in interest rate, the line of credit being yanked, etc. Credit is extremely important when running a business.
If your monthly mortgage payment is about the same as rent or less, why default eventhough you're underwater. If your monthly mortgage payment is several hundred dollars above rental parity, it is worth to some people to stay put just from a comfort level.
I know people that are underwater over $100k-$150k on their house and are still current on their mortgage payments. Because they were not in default, they were able to acquire investment properties recently. Their recent RE investments have yielded returns more than enough to cover for their monthly mortgage shortfall. Being short-sighted can cost you.
And lastly to echo what theoakman said above, some people have self respect & live up to their obligations. :)
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Darrell In Phoenix says
Clueless.
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In my mind strategic defaulter = Squatter. Living in a house without paying for it. You could then be like that crazy family and continue living in it after foreclosure and it only strengths my argument (But your risk for jail time goes up considerably and I'm trying to avoid jail time in my argument).
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San Francisco, CA
E-man says
Because the opportunity cost isn't renting, it is paying nothing for 2 years and then renting.
I get your point about other aspects of your life that depend on your credit. However, after 7 years you would be good as new. And since you are strategically defaulting, you could get everything else you needed lined up before you default.
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You're wrong on point 6. You still need to pay insurance...you cannot take a chance on the house burning down or being destroyed in a storm. And anyway, if you are foolish enough to cancel your insurance the bank will purchase a policy and sue you for the premium.
Likewise on maintenance, you still have to pay. Either you will still be living in the place, or you will have tenants in there. Either way, you still need to maintain the a/c, heat, fixtures, etc. But you can get a homeowner's warrantee that will cover most of this stuff for you at a cost of only about 400 to 500 dollars annually.
They do charge a co-payment when they send a contractor out to fix a problem, but if you are renting the place out you can specify in the lease that the tenant will pay that co-payment. Also put in the lease that the tenant will be responsible for lawncare and landscaping and also for pool upkeep if applicable.
Lastly, you are also wrong about the taxes...but this time it's good news. If you default on your mortgage, I would also default on all property taxes. The county can't come after you personally, they will just eventually place a lien against the property in the amount of the unpaid taxes (this will probably take at least 3 years). So this would just be another claim against the property that will have to be worked out in the final disposition of the property. This is what I was told by an attorney.
So to sum up, what payments do you still have to make while in default on your mortgage and waiting for the foreclosure?
Homeowner insurance? Yes.
Maintenace? Yes (but get a home warrantee and you are covered).
Property taxes? No.
Hope this helps.
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Baltimore, MD
Because you have to be under water enough for it to be worth it.
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E-man says
Funny to hear it from the dude who openly stated that his investment plan includes walking away from his obligations if price of his investments plunge:
E-man says
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BobMSN says
Not necessarily.
Some people bought what they could afford, even though it was at an extremely high valuation off in some fringe neighborhood at the peak of the bubble.
Prices in these hoods cratered. A shack bought for $300,000 grand in 2006 is now worth $100,000. Inflation adjusted it was always worth $100k.
The hypothetical defaulter saw the writing on the wall, stopped paying the contract, abandoned the investment, and moved on. They are now eligible for a FHA insured loan with 3.5% down at historically low interest and prices.
The typical Squatter at this point, subprimes are long gone, has realized that it is foolish to be a victim of the ponzi scheme that made so many bankers, flippers, "investers", and lucky people wealthy.
The squatter told the bank, "Give me a better deal or take this house back". The bank does not want the house back. They make you talk to a debt collector whose only job is to squeeze more money out of you.
The banks ask for endless modification paperwork. They entice you with offers of lower interest and principle reduction. They do all they can to pretend that the original contract is enforcable.
The banks are bankrupt. They are slowly squeezing out a couple of houses, trying to maintain prices. They have caused a mini bubble of "investers" who see their fortune in exploiting poor renters.
Squatters don't necessarily want to squat, it's just that the system has made it the best option.
Investor - An individual who commits money to investment products with the expectation of financial return. Generally, the primary concern of an investor is to minimize risk while maximizing return, as opposed to a speculator, who is willing to accept a higher level of risk in the hopes of collecting higher-than-average profits.
Invester - see speculator in above definition.
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San Jose, CA
Clinging onto the hope of unrealistic price gain.
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People forget this is the age of retrofitted laws.
People walking away and defaulting today, are most likely to be sued or prosecuted in the no so far distant future. I really expect that to happen as soon as interest rates goes back up, and the banks and economy is back to making money for them selves. Right now they are busy standing at the US teller window with a money bag, Ben Bernanke keeps filling up for them. But when that window closes, everyone from banks, to investors that lost tons of money investing in those derivatives, to the Government them self will be going after these strategic defaulters.
I mean the process has already started, the Banks are already being sued for their part for loaning money to people that could not repay. After that is over and precedence has been set, that someone has to be at fault.
I'm most certain, that those where it can be proven that people were able to pay for their house, and were not victims but were in fact made a greedy bad investment decision, and decided to take the easy way out, even if they could afford to pay back the loan. Will find them selves in the hot seat.
Don't forget, Minorities are always the victim,(They weren't greedy, they were preyed on, even if they did fabricate documentation) everyone else has to be held accountable for their actions.
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Darrell In Phoenix says
Liar, it was a prediction, like I predicted banks will eventually just become landlords rather than let home prices settle naturally to a level the free market will support.
That was treated like a big whopper too.
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Atlanta, GA
Let's look at this objectively from the perspective of the contract that each party signed:
1. The bank may foreclose on the home if the buyer is not making payments.
2. In most states, claims against the buyer for defaulting on the home are limited to seizing the home. In other words, if the buyer defaults, the bank can take the home but can't come after the buyer for the loan.
3. Realistically, the buyer will ruin their credit rating by defaulting on their mortgage.
All things considered, it can make sense for many people to simply default on their underwater home. Does that make them unethical? Go and pose that question to major US airlines and automakers. They'll tell you that bankruptcy was a good business decision.
The bank has its rights and can foreclose on the home. But trying to guilt-trip people who are underwater to stay in their homes is hilarious, especially when it comes from banks that received massive government bailouts.
It's just business.
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San Francisco, CA
WhatDoIKnow says
Thanks for spelling that out, I wasn't sure at all what would need to still be paid.
SkyPirate says
It seems like on a case by case basis it would make sense for some owners to default and probably at a higher clip than we are currently seeing.
But I think that most people do have a sense of self worth attached to their home and credit score. Furthermore, we do live in a society that would consider it unfair to just leave a house, even if a bank would screw you over in a heart beat.
I might have glossed over a very important assumption at the begining - People are rational actors. I don't know if the average joe is smart enough to realize walking away from a home could be in his best interest.
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SkyPirate nailed it. The banks entered into a contract with people who had little or no chance of realistically fulfilling the terms of the contract. As a landlord, I could rent to a Taco Bell cashier and his family of 4, but don't go holding your breath cause I know he can't afford it.
As for those that strategically default. Turn the tables. If you held the mortgage, what do you think your bank would do if they started having trouble paying the bill? (They'd squat and exhaust every legal option available to them to stay as long as possible, and do it in a heartbeat)
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CaptainShuddup says
The contract was: money for house. no money no house.
Your words say it all:
"... were not victims but were in fact made a greedy bad investment decision". The financial industry made a bad investment in a real estate bubble, collected their fees, and now we all pay.
It is not moral to ask a family to suffer for the financial industry's shenanigans.
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robertoaribas's website
In Phoenix, you can be underwater and still paying a lot less than rent... that kind of changes the logic a bit.
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robertoaribas says
Only to a certain extent. The option is to pay nothing for 2 years and then rent or continue to pay the (below market) mortgage.
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Two close friends short sold recently to avoid forclosure. One was renting a house, the other was living in the house. It's been made so easy to short sell, why not just do that expect that residents must endure a move? I was surprised to be told that the recent government housing programs include subsidizing situations where a short sale doesn't pay back the mortgage such that the underwater amount is forgiven after the sale. Pretty sweet way to wash your hands of the decision to buy!
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You're left with no equity. With the foreclose and squat, you build back some cash.
A short sale is definitely a more reasonable way to do things; but not as interesting as my thought experiment. :)
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David Losh's website
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Man, you ask the good questions.
In a short sale you are required to provide financial information that may, or may not be contrary to your loan application, which would trigger fraud.
Give the banks nothing.
I think the jury is still out, at least for me, on whether these loans will stay underwater, or if banks will begin doing debt forgiveness in order to keep a loan.
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Asking why people don't strategically default, even when they might benefit in the short term, is like asking why they save for retirement or why they keep saving even when interest rates are below inflation. People value security. Also, defaulting may not be a sound strategy, even for people whose houses are underwater. For example, in judicial recourse states, they can be sued for the balance and costs and fees, and they may end up losing other assets. Other people see it as a matter of personal character. It's the grasshopper vs the ant: the grasshopper might default, and might even benefit from that, but the ant doesn't. The larger question is, why is America as a society encouraging default and punishing savings, encouraging grasshopper behavior while punishing ant behavior. FIRE lobbying and bailouts are pushing us all towards collective default, and a profound shift in national character.
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Oakland, CA
Few things...
- I am underwater on my primary residence property, but not enough for it to make business sense to walk away. There's a threshold obviously.
- Because I am acquiring more property, the savings of foreclosing and squatting for two years doesn't measure up to the potential gains of acquiring investment property. And a foreclosure black-eye could make things quite difficult for me to proceed.
- I am amused by the "moral obligation" mumbo-jumbo. Both parties went into a contractual agreement. One party lent money while the other party took on an asset. If, for whatever reason the party with the asset stops making payments, they give back the asset. And the bank is/was very well aware that if the financial system/economy collapsed, people would be exersizing that part of the agreement. And don't forget that the asset gets returned in full even though the owner paid for that asset for years! Oh how well positioned is that bank compared to the rest of us eh?
- The bank will ALWAYS exersize every possible legal avenue to extract the most money out of any particular contractual agreement. Sometimes the little guy will be smart enough to do the same. I applaud all of you who have improved your lives by moving on from your debts legally. And at the same time to be fair, I am disgusted in our system for continually offering the "outs"
curious2 says
Spot on sir.
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David Losh's website
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Number one the bank writes the contract to suit them. The bank does the appraisal, and has all the data on larger economic forces that come to bear on the Real Estate Industry. The bank lends money on the value of the asset.
There may be a promise to pay, but the promise to pay is secondary to the whole foreclosure market.
Ask why the foreclosure market is overwhelmed.
Banks didn't care how much they lent, they were selling the Notes as fast as they were churning them out. Those Notes were sold to a secondary market without any regard for the value. Those loans were insured against loss, and resold as investment quality based on a rating system.
How could the entire financial market have missed the mark on the value of the assets.
Now ask yourself, if they didn't know how could you be expected to know. If they lied, or ignored, they should be the ones taking the loss, not you.
Either way, walking makes the most sense if the numbers make sense to you.
The bank is the enemy, give them nothing.
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curious2 says
Could it be because the worst actors among us saw an opportunity? Instead of dealing with reality and investing in creating a workable, livable future they chose to: 1)Collude with a totalitarian government to avoid environmental laws, labor laws, accountability and US domestic competition and resurrect slave labor (Nixon in China). 2) Creat a totally fiat world currency run by crony banksters and their political puppets (Nixon again) 3) Expand irresponsible government spending agreed to in exchange for lowering of the top tax brackets which encouraged quasi criminal short term thinking and behavior aimed at accumulating vast personal fortunes that encouraged even more corruption of the poltical process. 4) Turn the natural desire and historical basis for middle class US property ownership into a tool to exploit the average citizen and resurrect the rentier class. By any objective measure we have arrived at a very f'd up destination.
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After Foreclosure's website
Guys, this article is from almost a year ago. Dec 2011. Things are different now.
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San Francisco, CA
jon says
For some reason the title of my thread changed and it got turned into a link submission. The focus here isn't at all on the article. Going to fix it now.
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IDDQD says
Thank you for proving my point about being short-sighted. Investors and I are buying properties in the Bay Area for 35-40 cents on the dollar. These properties are now worth 50%-60% of the peak value. In some parts of the country, you can buy them for 20-25 cents on the dollar. You bears are calling for another 65% drop from here.
If the bears' prediction comes to fruition, do you think you still have a job by then, or will the soup line be the norm? Ask your spouse if your first obligation is to put food on the table for your kids or pay mortgage to the banksters if SHTF? I hope your spouse dumps your sorry ass if your answer is the latter.
I know a couple of persons that are in a bind right now, but refuse to let the property go because they said "we know what we signed." You just have to respect that.
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Nobody says
As unrealistic as their hope, it has come to fruition this year for some homeowners. Have you seen the double digit gains in some parts of the Bay Area? :)
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Oakland, CA
E-man says
I have. And as a homeowner and an active investor, I don't know whether to celebrate or cry.
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People don't strategically default for the same reason that they vote for a democrat or a republican.
Path of least resistance, lack of knowledge, unwillingness to change. Actual answers from my under water friends and coworkers.
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Sakman says
In times of crisis, people generally don't judge others with as much scrutiny as they would in good times. How ever when the worm turns, and better times are ahead, and people can breath again. That's when they start to think about the stuff they saw along the way. It's then they want to hold people for what they did back then.
Those people that didn't strategically default, will hold them selves morally above those that did. It's no different than a college kid that will hoot an holler and cheer some college girl on as she strips at a patio bar wet T-Shirt contest.
How ever 10-15 years down the road, that girl wont stand a chance getting a job, when she shows up at that same persons office for a job interview.
"Hey I know you! Did you ever enter a wet t-shirt contest at the Elbow room on Las Olas back in '89?"
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San Ramon, CA
My parent's long time neighbor, got over 500K as a second on her house during the height of the bubble. She told my dad that she got her money, so the bank can have the house whenever they want it. She's been living rent free for over a year now. I double checked this on Zillow--she wasn't lying.
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Oakland, CA
CaptainShuddup says
I would expect that she would be the #1 candidate for the job, ahead of you and I.
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CaptainShuddup says
More likely some that missed the strategic default opportunity will regret their decision.
All cases are different but it is foolish to continue paying for an asset that is priced at less than 50% of it's original money mortgage balance. With amortization and traditional price increase it will take half of the loan term just to break even. Barring another bubble.
There are "investers" who are temporarily driving up the price of rent but wages won't support the higher rents in the long run. Americans won't live as serfs to the "nobility" class forever.
And who is going to buy all of the owned homes in the future?
All the sub primes never should have got a loan, and will never get a loan again.
Gen X and onward can't afford the mortgage, much less save the down payment for the baby boomers mini mansion.
The world is changing. The old American dream of a quiet neighborhood house with a white picket fence and neighbors that are friends is gone.
The American nightmare is expensive freeways, bedroom communities, jobs on the Internet, and communication that is instant, constant, and impersonal. Most of us serve instead of produce. We spend more time talking to clients and chatting to strangers than playing with our family.
Underwater homes, circling "investers", rising rent, no way out.
The paradigm is shifting.
And "when the paradigm shifts, we all start at zero".