Strategic Default or Efficient Breach?

Real Estate News & Current Events
15yFollow

Strategic Default or Efficient Breach?

Bryan Hancock
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes

I read the following article tonight:

Strategic Default or Efficient Breach?

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.

3Reply
179 views

Most Popular Reply

Eric M.
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).

4Reply
See this reply in the discussion

82 Replies

Jump to latestLatest
  • Marian Smith
    Real Estate Investor · Williamson County, TX · Member since 2011 · 1k+ posts · 961 votes
    14y

    What is unethical is to paint every room a different color, let your dogs pee on all the carpet, and move out leaving filth everywhere-- letting the lender foreclose.
    Also consider the area of the country--someone who moved to Phoenix and bought at the dizzing height created by liar loans and lying appraisers may not feel particularly guilty letting WaMu (whoever they are now) have their colateral back.
    Home equity loans are a different ball of wax. Texas' constitution barred them until a decade or so ago to protect the ranch from the poker table. Not a bad idea in hindsight.

    0Reply
  • Mark Moore
    Real Estate Investor · Walnut Creek, CA · Member since 2011 · 5 posts · 1 vote
    14y
    Originally posted by Bryan Hancock:
    Well the exact same argument can be made by the borrower. The borrower can say that they paid for the put provision in the financing and that they aren't inclined to make payments on a property that is $10 underwater.

    You are correct hypothetically. In actual practice, I have never seen the behavior you are describing, Bryan.

    My company has a program that allows severely underwater homeowners a chance to repurchase their home at or below current appraised value. As a result, we have met with many, many families in this situation.

    My experience is that these families have tried over and over again to work out a fair principal reduction with their lender. The *last* thing they want to do is stop making payments. And, most would accept principal reductions to values that are above current appraised value. On average, these borrowers try for 6 months or more to get a meeting with someone who can offer principal reduction, but they are told time and time again that they can't get a meeting as long as they are current.

    Theoretically, either party can push away from the table, but in actuality, it is the lenders that are refusing to even open discussions.

    Originally posted by Bryan Hancock:
    In these instances there is no zone of negotiation, which points to the fact that it is a business transaction in entirety. Nothing more, nothing less.

    I agree with you more than may come across, Bryan. But, under normal circumstances when a contract goes sideways, the parties come together to see if a solution can be found that is agreeable to both sides. That "zone of (re)negotiation" is what is morally expected, all parties to the contract working together in true good faith.

    When that zone of negotiation is terminated, the relationship becomes "just business". Nothing more, nothing less.

    0Reply
  • Bryan Hancock
    OP
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    14y
    Originally posted by Mark Moore:
    But, under normal circumstances when a contract goes sideways, the parties come together to see if a solution can be found that is agreeable to both sides. That "zone of (re)negotiation" is what is morally expected, all parties to the contract working together in true good faith.

    When that zone of negotiation is terminated, the relationship becomes "just business". Nothing more, nothing less.

    So would you agree that a blanket denial of adjustments to terms should be met in kind by the counterparty? If so, then wouldn't the logical conclusion be that it is just a business transaction since there is no opportunity for a zone of re-negotiation?

    0Reply
  • Mark Moore
    Real Estate Investor · Walnut Creek, CA · Member since 2011 · 5 posts · 1 vote
    14y
    Originally posted by Bryan Hancock:
    So would you agree that a blanket denial of adjustments to terms should be met in kind by the counterparty?

    Absolutely! I think this blanket denial to even consider adjustments on the part of the lenders is *exactly* what converts the severe underwater homeowner's decision to a ruthless (and morally justified) decision to default.

    I would add,though, that the homeowner should remain open to discussion all the way through. And, on the off chance their lender actually comes to their senses, the underwater homeowner should honestly be open to a principal reduction that is fair to the lender as well.

    But, the fact is that the banks are NOT open to discussion. Until then, the homeowner really has no other rational option than to ruthlessly maximize heir outcome. (IMHO)

    0Reply
  • Zachary Dosch
    Bismarck, ND · Member since 2011 · 142 posts · 16 votes
    14y

    Just have 5 years terms and 15-20% down. Yes, this would be very difficult but if people were truly interested in stabilizing the housing market for the long term, they would suck it up and stick to these guidelines. I think its terrible and bad business to even have to discuss this in the first place.

    0Reply
  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    14y

    Just came across this thread, and while I haven't read the whole thing, here's my quick $.02...

    Lender and borrower have a contract. At every point in the transaction (including at foreclosure), both sides are living up to their end of the contract. The contract doesn't indicate under what circumstances the borrower may choose not to continuing paying the debt; it only indicates the repercussions of not paying (foreclosure).

    Bank's lawyers and actuaries are not stupid -- they know the risks, and it's up to them to write the contracts in a way that both mitigate their risks and still attract customers; if they can't do that, the business fails (capitalism at it's finest).

    Assuming both parties signed with sufficient knowledge of the "rules," it's not clear to me what morals have to do with a business transaction and a mutually agreed-upon contract?

    Podcast Guest on Show The Truth About Real Estate Investing in 2024 (What Investors NEED to Know)
    1Reply
  • Rich Weese
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    14y

    JScott- Like most of your posts, this is WAY too logical. Others try to read more into something when it isn't there. All signers to a contract need to understand what the heck they're doing and they have every opportunity to seek counsel. Most earnest money agreements have that as a standard term. Rich

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free