Walk Away From Your Underwater Home?

Should you walk away from your home if the value is below the mortgage you owe on it? There is a growing chorus of academics and advisers who suggest you should. The so-called “strategic default” is becoming more commonplace. A strategic default is one where the borrower can afford to make the payments but chooses not to because the home is under water (its value is less than the loan amount).

The thing that keeps most people from doing this is a sense of moral obligation to make the payments. Interestingly, banks and other real estate investors have no such compunctions. If they feel it is in their best financial interest to walk away from an investment, they will do so in a heartbeat. From the :

Businesses — in particular Wall Street banks — make such calculations routinely. Morgan Stanley recently decided to stop making payments on five San Francisco office buildings. A Morgan Stanley fund purchased the buildings at the height of the boom, and their value has plunged. Nobody has said Morgan Stanley is immoral — perhaps because no one assumed it was moral to begin with. But the average American, as if sprung from some Franklinesque mythology, is supposed to honor his debts, or so says the mortgage industry as well as government officials.

Professor Ron White from the University of Arizona recently published a report in which he argued that more people should be walking away from their homes. From the :

“Homeowners should be walking away in droves,” according to White. “But they aren’t. And it’s not because the financial costs of foreclosure outweigh the benefits.” Sure, credit scores get whacked when you walk away, he acknowledges. But as long as you stay current with other creditors, “one can have a good credit rating again - meaning above 660 - within two years after a foreclosure.”

Better yet, you can default “strategically”: buy all the major items you’ll need for the next couple of years - a new car, even a new house - just before you pull the plug on your current mortgage lender.

This is a very interesting debate, and one that certainly has two sides to it. On the one hand, it is hard to justify paying hard earned money on an asset that is hopelessly underwater. Many people in some of the hardest hit areas are straddled with a financial weight that could take years to correct itself.

On the other hand, I hate to see a breakdown of personal responsibility, or to promote the idea that you can just walk away from your obligations if things get tough. And others would argue that by walking away from a home you are passing the cost and burden on to all of the taxpayers collectively. These are tough decisions, and tough times for many. Here’s hoping we can see continued improvement in the real estate market going forward, which is the ultimate solution to this.