Walking Away From Your Mortgage: Good Business or Bad Ethics?
Posted by SaveAFewThousand.com Blogging Team on Friday, November 5th, 2010 at 4:13am.Should American homeowners walk away from their homes and responsibilities of a mortgage? While it’s certainly an option, it’s a decision that should only be made after careful forethought. Unfortunately, subsidizing struggling American homeowners, usually just gives a temporary quick fix that ultimately fails the homeowner and puts them further in the hole. We need a solution that allows these homeowners an option to fail safely and rise up and try again.
Your Home’s Value is Down 50% - Now What?
Properties usually increase on pace with inflation. The housing bubble of 2000-2005 was an anomaly that will not be soon repeated. Predatory lending practices, no-down-payment loans to unqualified home buyers and mortgage fraud schemes culminated in a disaster that is going to take a long time to right.
A historical average indicates that most American homes will increase value by 3-4% per year. Assuming that a home has declined by 50% in value, it will take almost 24 years for it to attain the value that it sunk from, assuming the market has stabilized.
The problem is, of course, that the market has not stabilized everywhere. We most likely have another 3-7 years of this market before home values start to really recover in all markets. So, the next time a house will be worth what it once was may be about 30 years from now. This does not even take into account of the value of the dollar, which, by the time a home reaches the amount it fell from, will be worth considerably less.
Why Homeowners Walk Away
Let's say John Q Homeowner bought the 400K house that is now worth 200K. John Q., facing a large mortgage for a home worth half what he bought it for, decides to walk away and let the bank foreclose.
John rents a house for the next 7 years. Based on our 3% per year schedule, John comes back in at a value of $245,974. That's still $154,206 less than what he paid for the house! Is it any wonder that people are walking away from their mortgages when they can drop it all, take the hit on their credit and come back stronger than before?
In addition, John Q is most likely reducing his housing payment while he rents. Let’s say that John’s mortgage payment was $2,800 but he could rent the same house for about $1,500 per month. He’s saving $1,300 per month x 12 x 7 years = $109,200.
So in our example, 7 years have gone by. John buys back the old homestead at $245,974 and put $109,200 down on the house as a down payment. His new mortgage is now $136,774. His new mortgage payment is about the same as what he was renting for. He’s still saving a fortune.
People who can afford their mortgages or who have significant equity built up in their homes shouldn’t just walk away from them. Buying a home and paying it off makes good economic sense. At some point John and Jane will want to retire and they’ll be on a fixed income. Having a home they own free and clear is a critical piece of the puzzle. However, sometimes walking away makes the best financial sense.
Failure Should Be An Option
Why is the government subsidizing households that can't make their payments? Is that a fair use of tax dollars? Why not just let the system work without government assistance?
If John Q. Homeowner can't pay the bills, then he should suffer the consequences. He should lose his house to foreclosure and go rent a home until he can demonstrate ability to repay another loan. If that causes home values to drop in general, so be it. There shouldn't be a government guarantee that home prices will never go down.
The lenders and government are rewarding the wrong behavior. Instead of lowering the mortgage payments for folks that can't afford their homes, why not lower the payments for people that can afford their homes?
Help Those Who Help Themselves
For example, say John Q. can't swim and he is drowning in a pool of water 8 feet deep. If John is only 5 feet tall, what good does it do to lower the water from 8 feet to 6 feet? John is still going to drown.
On the other hand if you took the same resources and lowered the water 2 feet in a pool of water that was only 4 feet deep for Jane R. Doe, who is 5 feet tall, she should be able to get out of the pool.
The point is that, by investing resources into sustainable households, that money saved each month would either; 1) be saved (good for the economy) or 2) spent (good for the economy). By investing resources into unsustainable households, you're just pouring money into a black hole. What good does it do? They still can't afford to live in the home, and the data suggests that you are merely delaying the inevitable.
Where is the wisdom in trying to save homes from foreclosure that have little or no equity and owners that can’t afford them? We don't need a new system, we need to let the system we have work. If you can't pay your bills, then let the house go through a short sale, foreclosure, or bankruptcy. Go live somewhere you can afford. If this action lowers the cost of housing for everyone, then so be it. Isn't that good for the country? We shouldn't try to artificially prop up market values. Just like we shouldn't try to prop up artificial soy bean prices or prices of jeans at the GAP or Dora the Explorer DVDs.
“Home of the Brave” Isn’t Just a Song Lyric
The United States of America should be the land of the free and the home of the brave. Well, we should endeavor to always remain free, and freedom in the USA these days means having a low threshold of debt. Ask anyone that has a high level of debt if they feel free and see what they say. They are a slave to their job and to their lenders. As a country we need to drive down our level of debt and increase our savings rate. This in turn will free up capital to be invested, which will in turn lead to the creation of jobs. Letting houses go through short sales, foreclosures, etc is a start in the right direction.
We should also be the home of the brave.
We should be brave enough to fail and suffer the consequences. If you can't make your payments you shouldn't be vilified, you should be given an honorable way out of an unsustainable situation. This is achieved through foreclosure, short sale and bankruptcy. Over time with hard work, adequate savings, and demonstrated ability to repay a loan, you will be able to buyer another home.
But please, don't be afraid to take the necessary step in admitting to yourself that you are on the wrong path. We have to stop this thinking of "No One Left Behind" because what it's really doing is making it impossible for anyone to get ahead. Be brave. Be brave enough to face the facts. Be brave enough to be honest with yourself and your finances. If you don't, then I'm afraid you'll never be free.
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