When I wrote the post What is “Strategic Default” and Should You Consider It?, I was tough on those who have used this tactic.
First, a definition: Strategic Default, according to Wikipedia, is “the decision by a borrower to stop making payments (i.e. default) on a debt despite having the financial ability to make the payments.”
A brief summary of this post: I recommended “Don’t do it” for the following reasons:
- It is short sighted…getting out at the bottom of the market could backfire if the market rebounds.
- The lender will come after you (if you don’t live in a non-recourse state).
- You will trash your credit.
- You signed up for the ride.
I closed the post with these words:
“I am not unsympathetic toward those whose homes have plummeted in value during the recent recession. Many have simply been dealt a bad hand. However, true character is defined by how people respond to difficult times. A strategic default is a fancy term for intentionally breaking a contract because it doesn’t suit you at the time. I wonder: what else would you also bail out on when things don’t go well?
Hopefully, you don’t want to find out. Do the right thing now so you can stand tall in your own eyes. That is your only choice.”
I recently received the following comment which is causing me to have second thoughts.
“I live in S. Florida and am 123% upside down. I paid $223,000 in 2005 and a house 3 doors down just sold for $100,000. I will never make that money back (including my $50,000 down payment).
When I bought my first home in 1996, the bank practically wanted my DNA to get approved. The amount of hoops and fact checking was absolutely amazing!! The banks threw their strict lending practices right out the window and caused the housing bubble which eventually collapsed.
Are you telling me that as a 46 year old man that I have to mortgage my entire future to pay for the problem the banks caused?
I signed a business contract and the deal was I pay the loan or they get the house. I’m defaulting and they are getting the house! It’s nit my fault the house is worth less, it’s the banks! They caused the problem!”
Why the second thoughts?
His last paragraph. I confess that I hadn’t quite considered a mortgage in this light: “A business contract“…”I pay the loan or they get the house.”
Invitation for comments: Does my reader have a valid point? Have I been too harsh on those who opt for strategic defaults? Does blaming the bank (or any other entity) justify a strategic default? Are there moral principles involved, or is this simply a business decision…no more or no less?
I think I said it in that original post – all it is a business contract! If the bank would foreclose on you if you stopped paying because you have had hardship why shouldn’t you do the same to them?
It is a business contract, but there are moral implications – all decisions have moral ramifications. How we deal with them is the bigger issue. In this case, a poor decision was made to purchase the home on credit back in 1996. In essence, the purhaser spent money he did not have (anticipated future income) for the benefit if living in the present. He obligated his future self to pay this debt for the next 10, 20 or 30 years. Thus, he became controlled by the lender. Now he choses to break that contract, which is legally permissible, and will have financial repercussions in the future (difficulties borrowing money – which is not necessarily a ‘bad’ thing). Proverbs 22:7 puts is aptly: “The rich rule over the poor, and the borrower is the slave of the lender.”
There is a significant difference between morality (from a secular standpoint) and morality in God’s eyes, and this is one good example.
While it may be questionably moral from a humanistic standpoint (rationalized away by blaming the banks, although that’s questionable: no one held a gun to anyone’s head, forcing them to sign on the dotted line) the Bible is clear:
Psalms 37:21, “The wicked one is borrowing and does not pay it back”.
Or even more appropos to this situation:
Eccl 5: 4-5, “Pay what you owe. Better not to vow than you should vow and not pay.”
That seems pretty clear to me: “Better not to get a mortgage than to sign on the dotted line and then not pay”.
If Christians want to claim to possess the highest moral ground reserved for disciples of Jesus, they cannot follow the rules only when it’s convenient to do so, as if the rules are offered on an ala carte basis. If that means paying off $200k debt and not declaring BK, then so be it. Sometimes you literally have to pay for your principles, and put your money where your mouth is.
All of the justifications offered are only that: rationalizations attempting to justify why someone is not living up to Biblical standards. To do otherwise is hypocrisy, pure and simple….
I’m with you, Joe.
Part of taking a risk is the chance you could lose; and he lost big. Morally there is no question: he needs to pay.
Secondly, the “business contract” isn’t exactly what he’s making it out to be.
He purchased a product from the bank (the loan). He agreed to accept the product (the loan) for the price of the loan plus interest. He agreement was to make all his payments in some loan period (probably 30-years) in exchange for the loan.
Because of the risk involved in such a product, he offered his home in exchange for the loan. The agreement wasn’t the loan for the home, it was the loan for something of equal or greater value than the loan. Just because the product he purchased (the loan) is worth the same as his home doesn’t mean he purchased the home from the bank – he didn’t. He purchased the loan from the bank.
Thus his simplified “business agreement” is short-sighted (although, legal) and is a justification for his choice – not a right he’s owed.
I am the wife of the reader you quoted and I have a couple of things to add to the mix. First, I wholeheartedly believe that every person who passes judgment on our situation is obviously not in our situation, nor ever has been in a situation like this. I assure you that I would feel the same way if it had not happened to me. Just like most of you, we bought our first home, payed the mortgage, lived in it for many years, sold it, and made a profit. We had to relocate when we bought our next home in 2005; but let me tell you that we did we did NOT get on the bandwagon and buy a big, huge house that we couldn’t afford. We bought the absoulte smallest and cheapest house available in our area — a TWO BEDROOM CONDO!! Yes, a two bedroom condo for $223,000 was the absoulte cheapest thing in our area. Now, with two growing kids, a dog, a cat, and a home-based business, we have simply outgrown this space; but due to this situation (being underwater) we are stuck and cannot move.
As to the point where “no one stuck a gun to my head,” I reply you that I DID feel VERY cornered into buying a home that I knew was an over-inflated price — all the homes were over-inflated at that time, which is why we opted for the 2-bedroom condo. Additionally, conventional wisdom was ingrained in us by our economic system that it is ALWAYS better to buy then to rent. Six years ago, we felt that we had no choice but to buy “something” instead of rent. No one thought it was conceivable that we would lose our $50,000 down and our home would plummet in value.
Again, to those who do cannot see the other side of this, let me tell you how much it kills me that a young, 20 something couple now can buy a decent home in a decent neighborhood, go with the mortgage and build their life. We, however, are stuck FOREVER in this home…years and years without building any equity – and what kind of security is that in an emergency, especially as we get older? Our younger counterparts, however, can continue to pay their mortgage and build their equity as normal as years go by.
We have been nothing but honest, hard-working citizens, who trusted the banks along our economic system and conventional wisdom, but now have become vicitmized. That’s just how I feel, like a victim. I simply cannot move my growing family into another home without defaulting, there is no way out.
Melissa,
I don’t think we’re doubting your right to make this choice. Or that you’re necessarily even making the wrong one for your situation. The question is whether the justification that “this is a business contract” is morally legit assuming you can make the payments (either through renting the condo or making enough money to cover this payment and another mortgage or rental payment).
The consensus is, you are completely within your rights legally to make this decision, but is it the morally correct choice assuming you can make the payments? No.
Are we going to hate you or look down on you for making this choice? Certainly not.
God Bless. Sounds like this was a very hard lesson learned.
I think the biggest issue is that at the end of the day the bank owns the home. That is the bottom line and no matter how much equity a person has earned on paper the bank can still take it back if even a few payments are missed. The home is not owned by percentages or portions. I posted an article and did quite a bit of research about the loan modification program and it was evident that the banks would rather take the homes back than renegotiate the loan for whatever reason http://inthetrenches2009.blogspot.com/2010/08/nearly-50-percent-leave-obama-mortgage.html
Another situation I wrote about was regarding how Chase bank absolutely ruined my credit rating over $15 that was recorded against the wrong account.
Who ends up with the house when a person quits paying a mortgage for any reason? The owner – the bank.
I have been in your camp Joe, you sign a contract, you make a decision, you live with it. However, now you are making ME rethink my stance!
The part that bothers me I think is that other people may be affected when you walk away from your house. Take my neighbors for instance, who have done just that. The property is languishing. Their decision will ultimately affect my property value when the house sells for less because of its poor condition.
Thanks for making me think though.
To all:
Thank you for taking the time to think through this situation and make such thoughtful comments. Melissa, I especially thank you for sharing more from your perspective. We all agree that Melissa and her family are in a tough, tough place, requiring tough, tough decisions. I think we also agree that whatever direction Melissa and her family choose, we are not going to stand in judgment of them. I, for one, am learning that my moral high ground, even if I am correct, may ever so subtly bring about something in me I am not proud of: I find myself thinking too much of myself or too little of one who is experiencing something I haven’t.
Melissa…we wish the very best for you and your family. Let us know how things go.
Quite frankly, I don’t think you were too harsh at all. The gentleman who made that comment (and his wife Melissa) made a bad buy. Over a long period of time, houses go up 2-3% a year. It was their responsibility to make sure that the investment they made in that condo wasn’t overpriced. If a similar condo is selling for $100k now, then 10 years ago, it was probably selling for about that much. In 2005, when they went to go buy their house, don’t you think it’s a cause for concern that the value has gone up 150% in 5 years? That’s called a housing bubble, and people have to face the consequences.
And yes Joe, I completely agree that I will never know until I face it. But I know when I face it, I’d probably feel pretty morally low by strategically filing bankruptcy.
I feel for Melissa and her family and we did have a similar situation a number of years ago. We made a profit on our first home and ended up losing it on the 2nd home. While we were able to eventually pull out of the mess (by renting the house while it was on the market), it was certainly not as difficult as what this family is going through.
I would have to agree with Joe, however, and here are my thoughts:
1. The house may “belong to the bank” but do you realize that the bank is backed up by the taxpayer? If a bank is in trouble then the government has agreed to help them. This is a simplistic explanation, but if you have a govt backed mortgage, then the taxpayer is on the hook and not the bank.
2. Every home that is foreclosed and ultimately sold at auction lowers the value of all other homes in the neighborhood. In order to appraise a home, comparisons are taken. The low-ball sales which happen over foreclosure hurt everyone in the neighborhood.
3. Banks are now starting to pursue people for the balance. It used to be that they would just write off the balance, but now so many are doing this that they have started chasing the money down. On the other side – if you had equity in your home and lost it to a foreclosure wouldn’t you demand the balance? As far as I know the bank only gets the value of the mortgage and the remaining goes to the homeowner. You could end up destroying your credit – not being able to get another loan for 7 years plus having to pay the entire amount of the mortgage anyway.
Finally, we just went through a refinancing and yes we signed a contract. Not to be sarcastic, truly, but the paper said either you pay $X or we lose our home. It did not say “either you pay $X or the value of the house, whichever is less”. IOW you agreed to pay the mortgage amount, not the appraised or sale amount of the home.
I’m so sorry for your family. I empathize. But if you are able to make the payments, you should. You hurt others by walking away. I’m sure you are praying about this and looking for other solutions. Perhaps you could rent (even at a loss) until you can get back on your feet. If you could rent out your condo, then you may be able to rent or buy a larger home while you wait for the real estate values to go back up.
God always brings good out of bad (Romans 8:28). By not walking away from a mortgage you can afford you will win in the end. God will use this to bless your family.
I’m sure many will be praying for you as you have made your concerns known. We are all sorry for your hurt.
Kyle, you are totally clueless!! You say that it was our responsibility to make sure that our investment wasn’t overpriced?? The whole reason that America is in this situation is that ALL the houses were over priced at that time and the values were going up at an unprecedented rate. No one had ever experienced this before!! No one new what a “housing bubble” was. I certainly never heard of it. We were always taught that a house is an INVESTMENT; yes, as you say going up a little bit in value every year. Renting is throwing your money away. This isn’t the stock market! Homes don’t lose 100% of their value!
So don’t sit there and say that we basically shouldn’t have made such a stupid decision. Initially, We had $50,000 to put down and we were out of the housing market for a year (due to a ministry situation). Our goal was to buy a $100,000 0 $125,000 home and have a minimal mortgage and be paid off in a short period of time. Sounds great! When we went to buy again, we couldn’t buy a $100,000 house at all. I KID YOU NOT THAT A CRACK HOUSE IN THIS AREA WAS GOING FOR $125,000!! We looked at one house for a little over $200,000 and I went home and did my research and there were 4 sexual predators just in that neighborhood!!! I am dead honest with you. People were buying homes and the values were going up and up. I agree it was ridiculous what they were charging for these homes! The ONLY choice we had was to rent or buy this small condo. Again, we were not playing the stock market here. Why would a couple in their 30s and 40s chose to rent over investing in a home? Would we have to rent forever? A house is an ASSET, right? That’s what we were always told. At least we would have “something.” We didn’t know what the future would hold. No one new. So don’t even sit back and pretend that you would have made a better choice.
Melissa,
You ARE and WERE totally clueless.
Many potential buyers DID perform their due diligence and recognized a bubble, and listened to the economists sounding alarms (Talib, Roussini, Thornberg). I saw it quite clearly, because unlike what you state, we HAVE been down this road MANY times
(I’d suggest you read a good book on market bubbles: here’s a link)
“http://en.wikipedia.org/wiki/Extraordinary_Popular_Delusions_and_the_Madness_of_Crowds#Economic_bubbles
In fact, I had the cash (and VHA eligibility) to buy before the peak, but refused to, despite much pressure from others (family, etc) to keep pumping the market to even crazier unsustainable heights. I knew market dynamics, and saw a devastating crash coming on the horizon. In fact, I was surprised when it didn’t crash FASTER than it did.
(And yes, I tried to profit from the foolishness of others, shorting real estate and banker stocks that eventually plummeted. Dangerous business shorting, as timing is critical: I shorted too early, and actually lost some due to not properly timing entry and exit)…
So aside from $ lost on Wall St, what did I lose by not joining in on the madness, and remain sitting on the sidelines?
For one, I was denied the opportunity to BUY a home and build equity, since I continued renting much longer than I wanted (I did the “rent vs own” calculation many times). So equity was NOT being built (paid as rent), which is obvious when you CANNOT build equity when the market gets as out of whack as it did. If you didn’t buy in on the ground floor and sell at the peak, you lost $$$. Buying a home shouldn’t be a trip to Vegas, and we’re now looking at at least a “lost decade” as occurred in Japan following THEIR bubble (which crashed a decade earlier, which was a HUGE hint).
While lenders/real estate agents/appraisers/mortgage brokers deserve the lions share of the blame, I don’t let the idiot buyers off the hook so easily (which is fine, as there’s plenty of blame to go around)…. Their idiocy and lack of due diligence let prices get so out of whack, letting the bubble run as long as it did.
Christopher Thornberg (at UCLA Anderson School of Business at the time) was sounding a dire warning from back in early-mid 2000’s: here’s a mainstream media interview he gave to PBS from 2005 where he was sounding the unheeded warning:
http://www.pbs.org/now/politics/thornberg.html
He had a video posted on YouTube (recorded in Feb 2006) worth a watch (it’s long, but worthwhile):
http://www.youtube.com/watch?v=BiqEacwADlE
PS ironic that some were so busy warning of upcoming Armageddon and God’s Judgement Day, when they didn’t listen to the obvious warnings of financial disaster that many economists were sounding…
Yes, Dave, I may have been clueless at the time, and I didn’t consider researching the economic crises of other countries when I decided to buy my house, and thousands of other people didn’t either. I could only project what was going to happen from my own knowledge and experience, and I was wrong. They don’t teach you everything you need to know in life when you’re in college.
After partcipating in this blog, I have learned that everyone has their own story and their own two cents, and you just can’t understand where someone is coming from until you experience it yourself. All we can do now is warn and educate the next generation, just like those who experienced the Great Depression tried to warn us.
Very good discussion because it does point out the options and primary elements quite clearly and hopefully in a constructive way. The two items I did not see discussed much in the general sense:
1. Can the person afford the payments. Hard to argue morals if a person simply cannot pay something due to loss of job or variable interest rate doubling their payment amount. Can’t is can’t and that radically effects the choices and decisions one has to make.
2. Home value. The entire issue of market value has taken the forefront in the past couple of decades. It is one of the factors that has turned our homes into houses and investments. If a person is intending to live in their home for the rest of their lives the primary thing the market value does is establish the property tax rate. My home is the place if peacefully and affordable want to live. A house is an investment or business transaction. The two do not always have the same objectives.
Sadly, over the years Christians in general have adopted the same money management practices as the world and we are therefore reaping the same consequences. This is our wake up call and I am thankful to people like Joe for diligently striving to dig in and share Biblical standards and acknowledging that he is still learning them himself and therefore has room for change and growth. There is an old expression that Christians are the only army that shoot their own wounded and we need to be careful that we do not fall into this mindset.