btw, Permission was given by the author to copy the piece.
Increasingly, I see references to the ethical considerations with respect to defaulting on a home purchase loan as a response to declining home values. In a few words, there are no ethical considerations with respect to defaulting on a home purchase loan as a response to declining values in jurisdictions where explicit "non-recourse" laws are on the books.
In various jurisdictions, California being one of them, the lawmakers thought about it for a while and came to the conclusion that the multi-way negotiation between a home buyer, home seller, real estate broker, and mortgage lender was not a negotiation between parties of equal sophistication in financial matters, and that there was risk that the home buyer would be taken advantage of by the other parties, who were (accurately) thought to have greater knowledge, experience, and resources, in most cases.
The lawmakers then wrote laws which said, in effect, that the home buyer had rights which could not be signed away, because they are protections of the law, superior to any words in the contract. The "non-recourse" laws hold that a lender who makes a loan to a home buyer, the entire proceeds of which are used exclusively for the acquisition of the home, bears the entire burden of insuring that the home-as-collateral has a true value that protects the lenders interest in the event of default by the borrower.
The clear intent of such laws is to expect the lender to have good knowledge of property values and to require down payments and/or mortgage insurance in a proper combination to adequately protect themselves in the event of borrower default. Substantial down payments are clearly the best case, creating the greatest incentive for the borrower to hold up his end of the bargain.
If a wealthy person, or a retirement/investment fund, or a foreign country turns money over to a lender to make home-purchase loans in non-recourse jurisdictions, they inherit the burden of protecting themselves, by insuring that the lenders are lending on a sound basis.
NON-RECOURSE LAWS ARE NOT IN THE CATEGORY OF LOOPHOLES OR UNINTENDED CONSEQUENCES. They are clear statements by lawmakers that lenders are responsible for their own welfare as to property valuations, and that home buyers will have some government-provided protection against overpaying due to the actions of more influential market participants.
The story plays out, with the investors, lenders, and government participants trying to figure out how to prevent home prices from receding to their natural levels. Perhaps government will figure out some action to stall further declines, allowing inflation to (eventually) establish a natural equilibrium, no longer requiring government intervention. Or perhaps home prices will continue declining. I predict the latter.
But don't try to make the owner-occupant-borrower the villain in this story. The non-recourse laws were clear instructions to lenders (and to investors supplying lenders with funds) to keep lending on a rational basis - instructions that went unheeded. Upside-down owner-occupant-borrowers have an option that was intentionally provided to them as a countermeasure to the actions of others (who were the ones acting unethically).
34 comments:
The story plays out, with the investors, lenders, and government participants trying to figure out how to prevent home prices from receding to their natural levels.
So cruel. It's so painful for those who buy house during this period to see their hard earned down payment evaporate within a year or so. I have to exercise my patience to the utmost so that I can win this battle of waiting game.
The homeowner is the least informed and sophisticated party in a home purchase, they trusted the words, laws expertise of the entire system only to get screwed.
Homeowners need to do what is best for their families as the system will do what is best for itself. I sleep very well at night knowing that what I am doing for homeowners is helping their position in these bad times. I do everything I can to increase their position when all the cards hit the floor, if that means suggesting a bankruptcy filing two days before the auction multiple times to delay the sale so be it.
Please, stop calling them homeowners. You're a homedebtor until you pay it off, but find out what happens if you stop paying property taxes.
"homeowner", indeed.
Yep, the best title we can hope for is fee simple title. Until the day we (the people) grow some big hairy nads again, the illusion of home ownership and allodial title will remain mythical.
There's one big misconception here. The author assumes those making the loans would be responsible for the loans. Hence would only do loans that they were confident that the homeowners would be able to pay back. As it turns out, the lenders did get paid back, but not by the homeowners. The lenders simply packaged up these risky loans and sold them to the gov't or wallstreet. Guess who's paying for the gov't and wallstreet? That's right, the taxpayer.
That is why non-recourse laws did not work as intended during the bubble. And we're all paying the price for it now.
If a homeowner walks away from a loan that they signed for, and hence promised to pay back, it is unethical to walk way. It may be what's best for their family, but that does not make it ethical.
Wonder why the MOB has such high compliance with their loan repayments? Its because there is consequences to non-repayment.
Kevin,
The contract states that if the homeowner fails to make payments, the bank gets the home back. What part of this equation is unethical? The homeowners are not taking the houses and going to Mexico with them. They are giving them back. It's the responsibility of the banks to get accurate appraisals of home values and to make sure they are only loaning money to those people who have steady jobs, good credit, and down payments. Accurate home values and down payment requirements usually save the banks from big losses, but they got greed in the bubble years and forgot these standards.
At the end of the day, there's nothing unethical about not being able to afford your mortgage payment. If you can't afford it, you can't afford it. The ethical thing to do is give it back to the bank quickly and not try to live in it rent free for 6 months.
tyrone.
What is your comment "but find out what happens if you stop paying property taxes.
about?
ButterMonkey,
If you can't afford it, then by all means give it back to the bank. My issue is with people that can afford it, but choose not to because they are underwater because they guess wrong. They still have their job, still make the same amount of money, and the mortgage is still the same, but because their house is not worth as much, decide that they would walk away and stick the taxpayers with the bill.
I used to have a problem with the walk aways that could afford the house. I don't anymore. If the banks had not been in such a feeding frenzy to make money from selling the loans to wall street, I doubt the bubble could have inflated to anywhere near the level it did. And let's be real, with normal 30 yr fixed loans most of those people couldn't afford the payments. They can only do it now because of the ALT-A loans where they are not making a full payment.
There's plenty of blame to go around but the banks are supposed to be the checks and balances here. People are stupid, they will spend as much as they can given an opportunity. It's up to the banks to make sure that they don't lend more to people than they ever have a hope of paying back. And if they are going to take that risk they had better damn well make sure the collateral is worth what it is supposed to be worth.
When I buy my house, I do not put the Bank welfare into considerations. I only concern what's good for me and my family. In the same way when the bank lends me the money, they only consider their benefits. It's a business deal, a financial agreement between two parties. I did not buy mine yet but also think walking away is the smart thing to do if you're under water. I see many live in the home rent free for more than a year now. They want the bank take it back but the bank did not do it. I guess they can live in rent free for another year or two. Good for them, bad for me. Life goes on. Like it or not.
Wow, the crux of your argument is if the bank is stupid enough to lend me money, I can feel free to default it at will. Talk about not taking any responsibility for your actions. But what's worse is not having any remorse over it, and even feeling justified in doing it.
Kind of like the honor system in some schools. If the teacher is dumb enough to trust us, then its their fault that we cheated on the test.
Do you guys feel this way towards friends, neighbors and relatives also? If you loan a friend money, do you expect repayment? If they friend or family decide that it was not in their best interest to repay you because you were stupid enough to loan them money/dvds/garden tools/etc., how would you feel? Is it ethical?
Your are mixing up ethics and a legal contract. The contract for the loan is simple. You make the payments or if you can't or don't then the bank takes the collateral back. End of story, both parties move on.
Another factor, most of us will do what we feel is best for us and our family. Would you throw away your financial future to keep paying for something that's now worth far less than you paid for it, when there is a perfectly legal way out? We are not talking about a $100 loan from you buddy here. In many cases we are talking about sums close to a million dollars over the life of the loan. It's idiotic to sacrifice your financial future for some moral standard than no one will care about or know about in a few years.
I'm torn because I know many of these people did know what they were doing and rolled the dice in the hopes of making a quick $100k. I'd like to see those people suffer a bit, it does seem only fair. But the contract they signed doesn't have a clause that will cause them any pain unfortunately.
Three years ago I came to the same conclusions. It's good to see more joining me. Now it is time to close the new loophole where the loan is foreclosed but the property not acquired.
I have been told my a law student, that there is an exception in California. That if you refi, they can come after you for the balance!
First mortgages are non recourse but second mortgages can be subject to recourse.
Not everyone is free and clear to walk away!
Look at this link, 4th post down! This person has a SCARY story!
http://community.lawyers.com/forums/real-estate/68741.aspx
Even with 15% unemployment, 85% are still employed and should have been able to make their payments. It's unethical for them to have bought houses they couldnt or didnt want to pay for and its unethical for the banks to have given them loans. I have no sympathy for either. The homeowner maybe the least informed but if someone does not understand what they getting into, they shouldnt have bought homes. That being said, I recently advised one my friends, who still is employed, to walk away. its just makes no financial sense to stay. Theres another group who refinaced their houses during the bubble and took lots of money out to buy luxury items, boats cars rvs, and now they are walking away too. That borders on unethical if you ask me. Not sure if their refinance loans are non recourse or not. These non recourse laws in theory do help keep banks from taking advantage of people so I wouldnt change them. Maybe the banks will be less likely to throw money at everyone with a pulse in the future because of these laws.
X,
That's whole point I was arguing, that even though it was legal, and financially prudent, it was unethical. Doesn't mean you shouldn't do what's best for your family, but that doesn't make it ethical.
Wow, lots of rationalization going on in here.
Switch the circumstances around: let's assume one's house increased dramatically in value and was worth much more than the mortgage. Is it also "ethical" for the bank to show up and take the house back?
Prudence and ethics are not mutually exclusive!
If the house doubles in value and you don't pay the bank is still going to take it just like they would if it halves in value. The upside in that case is that after the loan, the penalties, and the fees are taken the bank will give you whatever is left.
Christina is correct, the non-recourse loan is only the original purchase loan. Once you refi, you are into a recourse loan. This is why these mortgage mods are such a trap for the people taking them. They are trading a non-recourse loan for a recourse one. That could very well come back to bite em. However, I've not heard of any banks that have pursued a person after a foreclosure on a recourse loan. Maybe they will start now that so many people with other assets are walking away. The banks could start going after these folks but in the past it was very rare. Mostly because they people had nothing and it was not worth the trouble.
I have heard a variety of opinions stating that a straight refi with no cash out is also a non-recourse loan. Any lawyers or mortgage industry folks out there willing to comment?
It might depend on the state. The only non-recourse loan in California is a purchase loan. Refi's are not non-recourse in Ca regardless of whether you pull money out or not.
x,
Actually, in my example I wasn't assuming that the borrower was late on their payments. But rather that the bank could decide to renege on the deal because it would be prudent for them to do so. Just like others here are claiming that borrowers should do.
I certainly understand why borrowers choose to do this, and I'm not surprised that people act out of self-interest. But we shouldn't delude ourselves into believing that it isn't immoral with fancy rationalizations.
Brian, if the laws were written so as to allow the banks to "cancel the contract," give you your paid equity back, and take back the house, do you believe *for a second* that banks would hesitate to do so?
Ethics have nothing to do with it. The law is written how it is written, and it is no more unethical for a homebuyer to voluntarily default (and lose the home, along with the accompanying credit penalties) than it is (or was) for a bank to foreclose on a supposedly non-recourse loan, then file a 1099-C and send the IRS after the homebuyer to collect tens of thousands of dollars of taxes on "forgiven" debt.
People who make their livelihoods gaming the financial system have no room to cry foul on the rare occasion when the system works out in favor of the layman. Consider that without the bankruptcy "reforms" that the financial lobbyists pushed through in 2005, maybe homebuyers might be less inclined to simply default?
This was posted in comments on Jim the Realtor's blog. Thoughts?:
"Theoretically, Recourse protection is given up if refinanced, it has to be an original purchase money loan to be iron clad no recourse.
The nuance is that California has something called the “single action” rule. Which for non-judicial trustee sales means you can have the money or the house, but not both. So if you have one loan on a property and aren’t Michael Jackson or Lenny Dykstra (someone with big enough loans that the lender will pursue the lengthy and expensive judicial foreclosure) then you are effectively still a purchase money loan and are safe.
If you have two loans that were refinanced and the first forecloses (non-judicially).. you are on the hook for the second. If you have the same scenario and the second forecloses, you are free and clear (the second would settle up with the first and the second foreclosed so can’t come after you for the deficiency).
http://www.bubbleinfo.com/2009/07/recourse-loans-being-pursued/#comments
The explanation from the Jim the Realtor blog is correct with respect to foreclosures in CA.
If the lender takes back the property through a Trustee's sale (over 99.9% of the time), the lender cannot pursue a deficiency from the borrower or guarantor.
To get a deficiency judgement, the lender needs to pursue a judicial foreclosure (i.e. sue the borrower for the collateral and a deficiency). The lawsuits are expensive, easily delayed for a couple years, and not guaranteed to get any extra payment from the borrower. In determining the deficiency, the judge will likely average the banks low-ball and the borrower's wild-eyed estimate of the value of the collateral a few years hence.
Dan,
The bank has to file a 1099, so that they can deduct the loss. They already forgiven the debt. The 1099 is strictly between the ex-homeowner and the IRS.
Dan,
You seem to be saying that merely because we have established laws to deal with borrowers who behave immorally, that the existence of those laws negates the immoral behavior itself. That doesn't make any sense to me. The consequences for bad behavior on the part of the borrower (bad credit for instance) are indeed themselves simply punishment for bad (immoral) behavior.
By way of example, if a parent punishes a child. One cannot say that the child did not act badly because they received punishment?!
Let me also state that I certainly wouldn't classify ALL defaults by borrowers as immoral behavior. I am directly addressing those cases (which seem to be defended here) where a borrower who is able to repay a loan chooses not to merely out of self-interest. Understandable? Absolutely! Immoral? Also, absolutely!
Morals are created by society and to a certain extent defined by our laws. Our laws clearly state your options in this case. Brian, you obviously have a higher moral standard than most people. But at what point would you throw in the towel?
I chose to walk the "righteous" path during the last bust (early 90s) while many of my friends simply bailed. I stayed put, payed my upside down mortgage and was basically trapped for nearly 10 years. All of them were far better off than me 5 years down the road. They were able to buy nicer homes in better areas in the late 90's while I was stuck. What did my high moral standards get me? Nothing is what. No one cares that I paid my mortgage, no one even knows that I did. I can tell you from experience, doing the "right thing" just does not work out in the real world. I really, really wish it did, but it doesn't and I would not make the same mistake again.
My understanding is also that people who purchased their homes with 80/20's are not clear of their 20 since it is a second mortgage.
Although it was done at the time of the original purchase, second mortgages are still recourse loans.
I could care less about the ethical side of this. Its like "keeping up with the Jones'"
When your right about everything, your right and when they are wrong about everything, they are wrong. Just keep making good financial decisions for you, don't worry about them. Look to the next thing!
X- From the link I posted, it does appear that lenders are going after this person on their second mortgage recourse loans. It seems the lender is looking to recoup losses after the auction. PMI is looking GOOOD!
That link is almost a perfect example of what this post is saying. That is obviously a person that had crappy representation during the short sale. Their agent or lawyer should have made sure that all debts were discharged in full. If your lien holders are not discharging the debt if full you don't sign the papers. Let them (2nd's) foreclose and get nothing. Many lenders are now sneaking in verbiage on short sale contracts requiring the seller to pay any deficiencies later. A good agent or lawyer should catch these shenanigans.
x,
Good post, and I think we are in agreement. I am not claiming that acting both immorally and prudently are mutually exclusive, in fact, they are often congruous.
Assume I find a wallet on the street with $100 in it and that I have no possibility of getting caught if I keep it. Clearly, I am "better off" in the same sense of being "better off" that you are describing for your friends in the early 90s. Right?
Philosophers have been dealing with this problem (prudence versus morality) from at least Plato's time, and I don't suspect that we are going to solve it here. :) However, as I said above, let's not delude ourselves into thinking that one's prudent actions are also moral.
Brian, your response to me presumes from the start that the behavior in question is "immoral."
Part of the mortgage contract is that the buyer can elect to default and give the house back, with the repercussion being that their credit rating would be affected. This is an amoral action (meaning, neither moral nor immoral); it's simply a part of the contract.
The fact that, in the current market, the lender takes more of a penalty (in collateral value loss) than the borrower (in negative credit rating) does not somehow make the action less moral. If this borrower were voluntarily defaulting in 2005 on a house they bought in 1998, I seriously doubt you would call it "immoral".
The analogy you cite of a child's punishment would be more applicable, I think, if the borrower were committing a crime. In this case, there is no crime committed; the contract clearly provides for this situation.
Dan, Thanks for the response, it helps explain your position more fully.
I think however that you are improperly equating the concept of "default" (which is a failure to meet one's obligations) with an "option" (which is the right within an agreement to exercise a particular action).
Options can be exercised while still abiding by an agreement. By definition, default is the state of breaking an agreement. They are two very different concepts.
In other words, exercising an option under an agreement is consistent with meeting one's obligations. Defaulting on an agreement, even though the contract may state what happens in that event, is a failure to meet one's obligations.
A failure to meet one's obligations is immoral. No?
"A failure to meet one's obligations is immoral. No?"
Gawd, I hope not, or I'm gonna feel really bad the next time I forget to take the trash out.
"Gawd, I hope not, or I'm gonna feel really bad the next time I forget to take the trash out."
You didn't cover that in the pre-nup? :)
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