that speaks about the supposed "moral obligation" to continue making payments on an underwater mortgage. The article generally jives with my thought process, especially as it relates to non-recourse mortgages. Specifically:
1. "The risk that the lender would be left with the home instead of the stream of payments if the borrower defaulted, for any reason, is one that is allocated to the lender under such a contract
and
2. "...and is presumably reflected in the price (i.e., the interest rate and other costs) that the lender charged for the loan."
and
3. "The lender loses nothing when it gets exactly what it bargained to receive in relation to a risk that it was paid to voluntarily assume."
and
4. "After all, a deal’s a deal."
How is this unsound logic? I know many (most?) think that defaulting on a loan where the terms are clearly spelled out is somehow immoral. Many institutional borrowers are currently doing this without the same media attention and scrutiny.
Can someone please explain how this is unethical to me? I realize that I will likely be in the minority and I am prepared to take a beating if need-be. Please keep the thread civil though. I would really like to try to understand this.
Flipper/Rehabber · Louisville, KY · Member since 2008 · 1k+ posts · 1k+ votes
15y
I too used to think it was somehow "unethical" to "not pay your obligations". But in the case of a mortgage, I was swayed by the argument that defaulting on a mortgage is not "breaking the contract".
A mortgage and note form a "complete" agreement. I agree to either do this or do that. I agree to either pay the note as agreed or I will give the property back. It doesn't say I guarantee to pay the full amount no matter what. It says I will do one or the other. And the borrower agrees to that deal.
So as long as you give the house back when you cannot pay, (imo deed in lieu is the most moral way to do this) there is no breaking of any contract or any moral obligation.
It is only when you take steps to hold continue living in the house longer than the normal FC process would take or you damage the house or you stop paying assessments or taxes or other things that any moral obligation is broken.
If you pocket rent while not paying your mortgage, I think that is wrong too.
However, I do think asking for a loan mod and even a short sale is morally suspect. That is breaking your original deal and attempting to put the burden of the market decline or your job loss on someone else. Of course, it is their choice to accept the mod, so if they do, then fine. But people somehow have gotten this idea that a mod should be granted easily and they are entitled to a mod (or short sale or any other type of debt forgiveness).
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
I think many people are coming around to that belief now. I had a quite nasty back and forth with a BP member about this via email when I first started posting. People can be quite close-minded about things when someone disagrees with them.
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Let me see, I guess we need a new promissory note for some of you to use, so here it is, at least the part you need to modify.
I (We) the undersigned as borrower(s) do promise to pay, subcet to the terms herein contained, to the Holder the principal sum of ____________________($_________) Dollars.....etc.
Borrower agrees to make payments in the amount of ____________ beginning on the first day of ___________ and like date thereafter, based soley on the borrower(s) ability and desire to pay same, until the outstanding principal is fully paid or at such time as may be convient for borrower(s).
In the event of default by borrower(s), the assignment of rents made in connection with this obligation shall only be payable at the option of the borrower(s).
Hope that helps you in your moral decission making process in keeping with the terms of the agreement made.
See how that works for you at settlement. Good luck!
Real Estate Investor · Sunnyvale, CA · Member since 2010 · 79 posts · 53 votes
15y
"it seems ironic to me that entities like Fannie Mae, which are as responsible as any for creating the systemic risks that the default wave poses to the larger economy, are often as not the ones pushing the “strategic default†moral narrative."
I'd have more sympathy for the 'morality' angle if it was being pushed by someone who doesn't have a vested interest in getting their monthly payments.
I don't recall howls of anguish from lenders when 'no-doc' loans were all the rage, and I don't believe they were loosing sleep over borrowers who wouldn't be able to pay their ARM loans when they reset in the future.
Contracts were signed, they invoked the contract to get the collateral on the loan. Now, there's no legal recourse left for them so they fall back on 'patriotism' or 'morality' to try to encourage borrowers to keep paying.
If they wanted to play the 'moral' angle from the start, don't have a written contract but just take my word for it and seal the deal with a handshake.
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Originally posted by Matt R.:
" I'd have more sympathy for the 'morality' angle if it was being pushed by someone who doesn't have a vested interest in getting their monthly payments".
There is, he is called Judge or Your Honor.
Others might include; Father, Minister, Preacher, Rabbi, Teacher and other titles used by religious leaders.
Real Estate Investor · Sunnyvale, CA · Member since 2010 · 79 posts · 53 votes
15y
Hi Bill,
sorry - I don't get your point.
If I agree to the contract and penalties involved, then later swap my AT&T iPhone over to Verizon and pay my dues...what ethical lapse have I committed ?
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
None, in that situation, you paid out your obligation as agreed, you paid the penalty to break the contract to go with the other guy, it was agreed to up front by both parties, no problem at all.
If you want the same deal in your mortgage, use the changes I provided for the note, maybe add a short rated penalty to walk away instead of paying as agreed.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
I don't see how you reconcile the morality with the fact that a contract is signed either. It is either a business deal or it is a promise. I don't see how it can be both...especially when the lender is being compensated for the default risk.
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Technically, what you call a default risk, when the loan was made, was a net risk, after the sale of collateral, based on thousands of loans, so it really is not an argument as a preceived risk with compensation in itself.
Does the contract say that you agree and promise to repay, I believe that is a covenant in the contractual agreement.
Under the current circumstances, now knowing how many loans were originated and the fact that many lenders were not acting in good faith, I agree, that it is tempting to stick it to them, not saying they don't deserve it, but getting even will come at a price, that price might be a business decission at that time.
However, not paying the mortgage payments and keeping rents is theft, since in any non-owner occupied and most occupied mortgages there is language concerning the automatic assignment of rents. The minute you don't pay, especially intentionally, those rents do not belong to you! Anyone doing this should go to jail as they put a burden on the tenant as well.
It;s also a matter of the moral shades of our time, most younger persons do not see the moral responsibility of keeping their word or following through if it is not in their best interest. People older than I wouldn't dream of walking away from a bank loan, that would kill my father, yet I could see my son thumbing his nose at them on the way out, not that he would, but I could see it. Maybe I'm not being fair to the kid, but I also see teenagers with no sence of responsibility at all and when I was their age, I had already borrowed money from a lender and paid it back.
I have had a few younger investors who have said they feel the same was as I do, so I can't say all younger people, but there is no longer the stigma like there use to be with failing to keep a promise or doing what you said you would. And for some to look for ways to circumvent responsibility is even worse, IMO.
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
15y
I see no problem with people walking away if they so choose. There are consequences for walking away though. Not only for the homeowner or investor, but others. Lenders are going to be less willing to lend without in some way minimizing there risk.
Personally that last thing I would want to do is walk away. Fortunately as well I understand what I'm investing in, so there is less risk of being underwater or stuck with negative cash flow.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
There certainly are consequences Charles. To try to guilt someone into paying on a mortgage on an investment that is underwater several hundred thousand dollars is stupid though. It is especially stupid when the lender that is laying the guilt is likely partially responsible for the person defaulting to begin with.
To me the whole thing is a business transaction no matter how you slice it.
Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes
15y
In the early 80's I was working in a real estate office with a fellow who had inherited $200,000 and had put it down on a million dollars of prime real estate. These properties were bought on a contract with the seller.
As time went on financing started drying up and rates started to rise. With increasing rates came depreciation in values and investment real estate was impossible to sell.
In one year his values fell 20% wiping out his equity. The next year another 20% put him under water.
An attorney advised him to stop making pymts and to collect as much rent as possible while the seller foreclosed and to eventually just sign the property back to the seller.
Not too many years later values rebounded and today that property is worth millions.
I've wondered how he ever did sustaining such a loss without a possibility of recouping on those properties. We can feel sure he is kicking himself today.
Short-term thinking and greed brought us down. People destroyed businesses and lives taking short-term profits without thought of how their actions would affect others and the industry as a whole.
When people give up property to foreclosure it brings down property values and hurts others bringing down other values. Your advice to someone to walk away could eventually destroy your own portfolio.
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Well, obviously I'm wrong here. I'll stop feeling sorry for all the folks getting the shaft by the banks, it's just business without ethics, okay.
LOL, would you loan money to someone that that has "your" opinion?
Looks to me like the trend in real estate investing now is how do I take advantage of the situation to my benefit, going by the letter of the contract the way I want to read it. All I have to do is justify my actions to myself! Good luck with that!
And geeez, would I defend people walking away from their obligations because business takes a hit for awhile when I'm asking investors to trust me? I don't think so. My investors got every dime of their money, through thick or thin, I protected my investor/lenders and in doing so made alot more money!
Involved In Real Estate · Hyattsville , MD · Member since 2011 · 298 posts · 256 votes
15y
I think strategic default has its issues. We can argue about morality but the question is what does morality mean on a personal level. What is moral to me may not be moral to you- Meaning I don't steal but someone else has no problems doing that. I don't send emails about my uncle in south africa and ask someone to send me money by western union but people do it every day and have no problems with doing so, therefore what is moral to me is diffrent from moral to someone else.
Now from a level of walking away because it is strategic- I could be for or against that honestly. When someone gets a mortgage at that time- They felt it was a good deal as a matter a fact they probably felt they had more to gain than the bank at that time. They felt that the bank was getting the worse end of the deal as they would get rental income or a house to live and and appreciation and the bank would have to get a small payment however History has shown them that they made pretty bad business decisions -Maybe that was a property they bought way to high, maybe they were getting negative rent to start out and hoping for some appreciation.
But regardless they made a bad decision and now they see startegic default as a way of fixing it. Noone was standing on a step saying hey you got to buy this house now or you will be sorry..They made that decision all on thier own. If they had bought the property at the right price and making great cash flow- then the last thing they would be thinking about is walking away from it. So they made a bad investing choice and then walking away leads to other bad choices again when it ruins thier credit and prevents them from doing other deals for many years in the future.
People are there willing to loan big banks money who default and the FDIC is there to fix stuff. Who is there to fix stuff for the individual- No one is coming to rescue the individual and definately not the investor so you have to live whatever your decision for years. Noone is saying that an investor should keep a house with negative rent and still pay the mortgage but who told him to get that house with negative rent in the first place?
Sorry for the long post- I was reading the paper yesterday and they tell you the trustee sales and they show the mortgage amount owed and the intrest rate- Someone had taken out a mortgage in 2007 for 490k at an 11.5% intrest rate for a SFH what in the world was this person thinking when they got that mortgage, what made them think this was something they could afford to pay? Was there some person standing over them forcing them to sign? The answer is probably No. Noone forced them they just made a bad decision.
Real Estate Investor · Alpharetta, GA · Member since 2010 · 415 posts · 484 votes
15y
Well, at the very least, we've found a topic about which people are passionate.
For me, it all begins and ends with the word "strategic." That means that people are defaulting not because they have to, but because they want to. We're not talking about people who simply cannot pay. I have every sympathy for those people who are losing their homes because they've lost a job or endured some other awful event.
Instead, though, we're talking about people who choose not to pay. Naturally if someone simply doesn't have the money, they default. Nothing "strategic" about that.
Sure, the lender has collateral, and sure, the agreement is, "If you don't pay, we'll take the property back." And obviously when that agreement was written, the idea was that the property would be worth enough to cover the loan in the event it ever came that. So, did the lender take that risk? The risk that the property might lose value? Yes, of course. No one's arguing that.
However, the lender's primary criteria for underwriting any traditional loan is not the collateral itself but rather the borrower's ability to service the debt. Not willingness to service the debt, mind you, but ability.
And by definition, anyone who is contemplating a "strategic" default has the ability to pay. They just choose not to. Sort of a "Heads I win, Tails you lose" approach to borrowing. If real estate values held or went up, then the lender gets a small amount of interest. And if real estate values tank, well, too bad, so sad, you just take a 20% to 50% loss on your principal. Suckers.
And to try to blame the lenders for putting people into products they should not have been in, well, that just falls on deaf ears to me, again, when we are talking about people contemplating "strategic" default. Again, they have the ability to pay, so it's not like they got into something they couldn't handle. They're just choosing not to do so.
Somewhere along the line, someone made an analogy about breaking a cell phone contract and paying the termination fee. I don't think that's anywhere near an apples to apples here because, by design, that termination fee is meant to make the carrier whole. As we all know, that fee is meant to offset the money put out by the carrier to the hardware manufacturer to reduce or offset the cost of the phone.
Now, if the mortgage note said, "Feel free to cancel this deal any time, just pay us the difference between what you owe us and what the house is worth, if it's worth less," you'd have something to compare.
Again, I say that if you're OK with strategic default, then you should just get as much unsecured debt as possible and not make any payments. I mean, you have the ability to make the payments, but now you just choose not to do so.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Ability to pay does not mean that doing so won't be debilitating to the borrower. Joe and Jane bought a house near the bubble peak because the lenders that are supposed to be responsible let anyone with a pulse get a loan. This caused a severe rise in values. The system then tanks and Joe and Jane are $200k underwater. They need to move now because Joe lost his job and can't find one for 2 or so years paying around the same amount. They then "strategically default" on the loan to avoid massive negative cash flow that was a result of THE ACTIONS OF THE BANKS.
This is immoral? If so, I guess I have a warped sense of morality!
Involved In Real Estate · Hyattsville , MD · Member since 2011 · 298 posts · 256 votes
15y
If Joe and Jane default then that is not strategic that is lost of a job and unable to keep up with the mortgage payments and needing to move in order to live- You cant find a job for 2 yrs thats survival. If Joe and Jane bought the house and they are 200k underwater and Joe has had the same job for 14yrs and recieves constant raises and the only reason he is defaulting is because they no longer want to make payments on a house no longer worth that amount then that is strategic default.
How is it the banks fault? Noone forced these people to buy a house for x amount at the peak of the bubble. They choose to do that because they felt the bubble had further up to go and they wouldnt be the one left holding the bag when the music stopped. They were wrong and they are left holding the bag unfortunately. That is life- They made a business decision so did the bank. If they had bought 5yrs before and values had gone up 100% and they were able to sell for 200k more than they bought would it still be the banks fault or it is only the banks fault when the people come out on the losing end? I bought several houses during the years and if I bought at a bad time I have noone to blame but myself. We cannot be a society who seeks to blame everyone for our own choices.
Edit- I think the problem here is we are blaming the banks for this whole thing and that is only partly true- Everyone got greedy- The banks, the appraisers, the homeowners who saw others profiting and gaining massive net worth in real estate overnight, the hedgefunds who saw that they could use real estate to make profit for investors, the real estate agents who thought I can make more commission by selling a house for 500k than one for 180k. Everyone came togather and made a nice chunk of change except the person who chose to buy and now is underwater but they made the choice to buy.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Joe and Jane could also be newlyweds that were just buying a house at what the market rate was for property at the time. The market rate was REALLY distorted because THE BANKS lost their collective minds and issued poor loans that drove up property values.
The banks then want to rely on the morality argument when it is obvious that servicing debt after the fall is a poor financial decision. I for one don't fault the borrowers at all for walking away from these raw deals. Calling this behavior immoral is really rich!
Real Estate Investor · Brooklyn, NY · Member since 2011 · 34 posts · 3 votes
15y
Doesn't "strategic default" open the door to the following scenario? Buy a house for a cash discount. Refi at 80% ARV. Use the proceeds to flip a house or two or three, never making payments on the financing. Essentially walking away from the first house and playing with the bank's money. First flip or so may get you your 20% back. All very businesslike... The math is inexact, and I'm new, so I don't know how much friction is in the transactions (liquidity, fees, blah, blah).
It does feel wrong to me. People trade stocks on margin all the time. When the margin call comes, you liquidate the position, and sometimes you get clobbered. I understand that home ownership is different, but this is an investors community, right?
Isn't this what credit scoring agencies are supposed to control against?
Commercial Real Estate Broker · Moreno Valley, CA · Member since 2008 · 72 posts · 30 votes
15y
A strategic default is the decision by a homeowner to stop making payments on a loan despite having the financial ability to make the payments. In this definition, the homeowner is financially able to pay. The payments are not in question it’s the homeowner’s reasoning that is important. The homeowner might have evaluated; spending money on something that has lost value versus using their money elsewhere.
The strategic defaulter has reasoned or evaluated and come to a business decision. They ran the numbers and decided what made sense to them. Just as the banks run the numbers and decides what makes sense to them. The strategic defaulter and the banks are making a business decision.
So who is morally at fault? Neither, it’s not a moral issue. Business judgments not moral judgments are in play. Paraphrasing a movie quote…â€it’s just good businessâ€.
As a society we seem to pay lip service to 'morality,' but practice something else. The word morals brings up religion to me so I will substitute ethics. Initially, I thought ethical people naturally had an obligation to repay their loans, even if they were underwater. The flood of information about the unethical behavior of many bank officers, Wall Street brokers and other individuals involved in this mess have made me rethink my original hardline stance. When so-called experts take advantage of their positions and use their power to set up and profit from the people seeking their help, when contracts are pushed that overwhelmingly disadvantage one party, when laws and the legal system do not protect the ignorant but well-meaning individual, society breaks down. I realize that not everyone underwater was a victim of predatory practices, but at this point I don't care. Big institutions got bailed out and I and all of you are paying for it. As an ethical person (self-perceived, admittedly), in this unique and devastating market, I cannot fault someone for taking a strategic default to protect themselves as best they can. Obviously the legal system, the banks and the government won't protect them.
Orlando, FL · Member since 2009 · 2k+ posts · 282 votes
15y
I believe the term for this is "moral hazard" -- an economist's term for the risk that one party will act to the other's detriment based on the nature of the contract.
Real Estate Investor · Brooklyn, NY · Member since 2011 · 34 posts · 3 votes
15y
Friend of mine at a major investment bank justifying the bailout: "Isn't there a moral hazard in standing by to allow the U.S. credit system to crash?"
Everyone't got a perspective...
ObDisc: I am neither an economist nor an ethicist.
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
15y
Originally posted by Bryan Hancock:
Joe and Jane could also be newlyweds that were just buying a house at what the market rate was for property at the time. The market rate was REALLY distorted because THE BANKS lost their collective minds and issued poor loans that drove up property values.
The banks then want to rely on the morality argument when it is obvious that servicing debt after the fall is a poor financial decision. I for one don't fault the borrowers at all for walking away from these raw deals. Calling this behavior immoral is really rich!
As much as I would like to blame the banks, government or others for the housing bubble, at some point I have to take responsibility for my own actions. It seems that society in general would rather play the blame game than to take ownership of there life and responsibility for their decisions.
The housing bubble has created a situation that has tried many families. Do I blame people for walking away? No. Do I think it is a good thing? No.
Choosing to walk away from a loan is a personal situation and I'm not going to say it is wrong or right. What concerns me though is when we justify it afterwards with it was the bank's fault or the governments fault or someone elses fault. If your going to walk then at least take ownership of the decision.
There is a price for walking for both the family and the rest of us. it also creates an opportunity for some while creating extra hurdles for others.
I sure don't want to spend the energy calling it moral or immoral. It is what it is. Many have already walked. Probably many more will. In the meantime the lending industry will change and adjust to the new playing field.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Yeah...there is plenty of blame to go around Charles. I am not saying that people should not take responsibility for their actions. I am saying that calling walking away from the situation given the parameters and original deal is not immoral IMO.