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The Morality of Walking Away from a Home Loan

Angel and devil pulling on either arm of man
As the housing market continues to rip through American homeowners’ lives, causing destruction, stress, heartache, and uncertainty, the rise of foreclosures refuses to cease. Mortgage loan holders are finding their backs growing weak as their underwater assets sit heavily upon them. Monthly payments laugh hysterically in loan holder’s faces as they longingly look at their neighbors who are paying half the cost for the exact same property.
 
Whether a lender repossess a house due to a legitimate default, or whether a lender takes a home back from someone who willingly gives their home up despite their ability to pay, to most of society, foreclosure is seen as a condemning scarlet “A” painted across defaulters' chests.
 
But why does society see foreclosure as a horrendous act of irresponsibility?
 
Taken at face value, many see resorting to foreclosure as an inability to meet an agreement—borrowing out of one’s means and irresponsibly taking money from a lender. But the real answer to that question reveals that society is very unfamiliar with the contracts homeowners sign.
 
Foreclosure—A Detrimental Experience
 
Mortgage loan holders enter into foreclosure for a variety of reasons—and none of those reasons alleviate the fact that foreclosure is a stressful event.
 
Foreclosure occurs when borrowers are unable to meet the monthly payments for their property. Historically, this happened most often as a result of a lost job or a major tragedy, such as divorce or death. With the housing collapse, certainly many lost their jobs and had to hand their houses back to lenders, but in the last few years the nation has seen something a little different: even the employed and financially-able were defaulting and being foreclosed on.
 
Underwater homes refer to properties that are worth less than a borrower owes on them. This happens as a result of a decline in value. The nation became riddled with underwater homes as the market collapsed since home loan holders who bought peak-priced houses at the turn of the century and then saw their homes’ values get slashed between 2007 and the present.
 
What resulted was a plethora of mortgage loans for $300,000 and $400,000 existing on homes that were valued at $200,000. If homeowners tried to sell their homes in that situation, they’d find themselves without property, and still a hundred thousand dollars short of paying their debt off.
 
As a result, homeowners everywhere just stopped paying their mortgage. This decision to willingly allow one’s property to be foreclosed upon became an unexpected phenomenon that swept across the nation. This act became known as “strategically defaulting,” or “walking away.”
 
Those choosing to walk away from their homes became so numerous, that, according to a joint study on strategic defaults done by the University of Chicago, Northwestern University, and European University Institute, 26 percent of all recorded defaults that occurred between the collapse and 2009 were strategic—meaning that one out of four homeowners who were foreclosed on could afford their payments, but allowed it to happen anyways.
 
There is a misconception, though, that those who walk away from their home do so hap hazardously and without regard to a financial obligation all homeowners acquire when they decide to take out a home loan. Some profess that those who walk away break a “promise” they made to a lender. On the contrary: most homeowners who walk away from their homes do so in complete accordance to their contract that both they and their lenders agreed to upon signing it. And despite abiding by their contractual obligations, those who walk away also suffer a severe blow to their credit score, and receive a black mark on their records that’s currently preventing them from obtaining a Fannie-backed home loan for at least seven years.
 
What’s in a Contract?
 
A default, according to the U.S. Department of Housing and Urban Development’s (HUDs) glossary, takes place “when payment has not been paid after 60 to 90 days.”
 
The contract signed between homeowner and lender consists of terms in which the lender gives the homeowner money that is to be paid off over an agreed upon time period, at an agreed upon interest rate. But the lender wouldn’t just grant money backed by a stranger's promise. Rather, the lender requires collateral before administering any money. In order to secure a home loan, a homeowner must willingly put his property on the line.
 
Then, if a homeowner defaults on their loan, the lender may take the property back as collateral.
 
This agreement is similar to that which occurs in pawn shops every day. If an antique owner needs a quick bit of cash, he can run into a pawn shop and get his antique appraised. The pawn shop will take a look at the object, estimate what he can get for the object if he were to sell it himself, and then offers the antique owner some money (assuredly less than the true value of the object). The agreement is made such that if the antique owner takes the pawn shop’s money, then refuses to pay it back, the pawn shop can turn the collateral over for a profit.
 
Mortgage loans are performed in the exact same way.
 
Except, when the property declines in value, the lender bites the bullet much like the homeowner does. That’s not immoral—that’s business. There is nothing shameful, embarrassing, unethical, or immoral about defaulting on a home loan. It’s a simple financial move that some do intentionally, while others would trade near anything to avoid. But at the end of the day, it’s nothing more than adhering to the contract signed by both parties.
 
What’s Good for the Individual may not be Good for Society
 

Before making such a drastic move as intentionally walking away from a property, individuals who own underwater homes need to pay special attention to their individual state’s laws regarding mortgage loans. Walking away from a home is best saved for those in non-recourse states—states in which a lender cannot reclaim real estate in addition to borrowers’ personal property or paychecks in order to satisfy the difference between the unsatisfied home loan and what the property is currently worth. Recourse states, on the other hand, allow exactly that.
 
Information on individual state’s laws can be found on HUDs State Information page.
 
With that in mind, the decision to strategically default may not necessarily be the most sound advice—when speaking from a utilitarian stand point.
 
If the near 25 percent of underwater homeowners decided to collectively default, the economy would collapse into something far more catastrophic than we’ve ever experienced. Banks would shatter, millions would be left on the street as rentals filled up, and the burden to correct the broken economy would fall to the tax payers. While strategically defaulting may prove to be a good move for the individual upside down home loan holder, it is certainly not good for society as a whole.