The Tipping Point
In a phone interview yesterday with a writer from the New York Daily News, I was asked…”Jon, where exactly is the tipping point? When do people realize it may be better to just walk away?” This is a difficult question, I said, because it’s not so clear cut. It depends on many factors. However, when it comes to specifically a “strategic defaut”, it may be a little more cut and dry. At what point does one decide to face the consequences of a foreclosure over pumping more & more money into a home with negative equity every month? Strategic Default can be defined as the growing trend of people who can afford to make their monthly mortgage payment, but due to the fact that they’re upside down on the mortgage or think they can get a better deal elsewhere, they voluntarily default on the mortgage. Often times they live in the home for a year or more, using that time to pay down other debts or save up money. Time will ultimately tell the real answer to this question, but I predict that this year we will see more and more homeowners tipping.
Homeowners Are Technically Renting
An article yesterday in the San Francisco Chronicle said
“The reality is, if you’re 30 percent underwater, you’re effectively going to be a renter in that home while paying your mortgage for the next 10 to 15 years before you get back to break-even with your equity,” said Paul Leonard, director of the California office for the Center for Responsible Lending.
“It’s not enough to have affordable monthly payments, if a borrower can walk across the street and rent some place for less, save money and have a little nest egg by the time their credit score recovers to be able to buy a home.”
And it’s not just a numbers game… in many cases it’s outside factors that cause someone people who have the means to pay to default – changes in jobs, suburban neighborhoods deteriorating as housing values plummet and changes in family life can all act as a catalyst for a financially stable person to voluntarily choose default.
“We could make our payment every month by doing a little bit of overtime,” said Jose Tolentino of the Bay Area of California. “But we want to start a family. We could rent for half what we’re paying and afford to have kids.”
In many cases, making this choice without needing a catalyst is the best financial decision an individual or a family can make. In a housing market where the majority of signs point to another decline in housing prices, and even the most optimistic of economists and analysts don’t expect any price increases like what we saw during the boom years, it can take years, in many cases decades to recover the equity that’s already been lost.
Brent White, a law professor at the University of Arizona, says that the number of true strategic defaults – people walking away from underwater homes in the absence of other problems such as job loss – seems lower than common sense would dictate.
“People are acting against their own economic self-interest by continuing to pay off houses where they may not have any equity for decades,” he said. “They’re throwing away good money after bad.”
Shame, guilt and fear stop many homeowners from reneging on their mortgages, he said. The government and big banks actively cultivate those emotional constraints because the economic consequences of a large-scale walkaway phenomenon could be dire, he said.
Sure, there’s a credit hit to be considered, and in certain states there may be legal ramifications that a lender can take to try and pursue a deficiency judgment, and then there’s the ever popular “social stigma” attached to walking away, but at the end of the day, when painted in comparison with burdening yourself and future generations with the debt of one bad investment, the consequences start to pale quite a bit. Obviously every situation varies, but when looked at from a purely business standpoint, the Strategic Default option is starting to look better and better to the millions of underwater homeowners out there.
Please let us know what your thoughts are on the Strategic Default debate… at what point does it make sense? Or should one be obliged to pay the monthly mortgage at all costs?
Jon Maddux
CEO
www.YouWalkAway.com
Email me at: jon@youwalkaway.com
