Tuesday, March 10, 2009

Walking Away Is Not a Morality Issue

It's a financial decision. The more I read the crap about responsibility to honor your obligations the more it ticks me off. CNN has comments from some folks here about whether they will walk away (be foreclosed on), and the answers are generally not in line with the real world. For a much more in line with reality commentary go read this.

Imaginary situation, bought in 2006:
Purchase price: $800k
Down payment: $160k (20%)
Other closing costs/fees: $20k
Total principal paid on mortgage: ~$20k @ 6% interest

Current house value: $400k
Owner out: 100% of investment of $200k+
Bank out: $220k if owner walks, less if they renegotiate, or 34.5%, plus they got another ~$80 interest worth of payments.

The banks are not being screwed by those that walk nearly as much as those that walk have been screwed by the artificial run-up in prices. Now people who put less money down (like $0) are not out as much cash, but are still out 100% of whatever they did put in. Banks are out by a larger amount (dollars and percents), but still not 100%. In this case the bank also bears substantial responsibility for making the loan (well, bad investment on the property).

Mortgages leverage a greater percentage risk on the buyer, not the bank. It is only when values fall precipitously that banks suffer much loss from a foreclosure. Of course, it's also only when values fall precipitously that foreclosure becomes a major concern. Specifically, foreclosure becomes a threat when the "owner" has equity of zero or less. This is a good reason for banks to require something (anything) down (particularly from speculators, who should have been forced to invest much larger down payments than resident owners...2-5% down for a primary home is fine, for a second house/investment property 25-50% down is a must). In rising markets the amount banks require down decreases due to the assumption of being able to sell for more (i.e. equity will always be positive if values always rise). This, naturally, is idiotic. Banks, who are supposed to be the financial experts in the transaction, should know better than to assume that anything (including housing, gold, et cetera) could only go up.

While many buyers were being irresponsible, it is downright vicious to lay blame on them. Banks are supposed to go through underwriting to prevent just these problems...they are supposed to hire appraisers that give them real house values so that they do not put in too much...they are supposed to know what they are talking about. I have never placed much trust in banks (and I've addressed that here before), and I am math capable, so it wasn't hard for me to figure out what I could afford and whether prices were in line with reality. Most people are not nearly so adept with numbers and take for granted when experts tell them they can afford payments.

I think that buyers do have a responsibility to understand what they are getting into, but their responsibility is less than that of the lending institutions in this regard. Of course, in a foreclosure it is the buyer, not the bank, that is hurt the most. They lose everything they invested.

Foreclosure, walking away, is not the irresponsible thing to do. The irresponsibility occurred on closing day.

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