Letting go when you’re upside down on the house
Wow, isn’t this a hot topic lately? With home values dropping like a rock over the past few years, many homeowners are finding themselves upside down on their homes. As a result, increasing numbers of homeowners are finding the prospect of paying more for a home than it’s worth just too much to bear. So they’re just walking away from the mortgage and letting it default.
I have to say I’m rather frustrated by this logic and I wanted to share a few of my thoughts on the topic. People often ask me where I stand on the issue and now I’m going on record with my opinion.
Before I go much further into this conversation I want to be clear that I’m not talking about people whose income dropped and they’re no longer able to afford their mortgage payments. They have a legitimate reason for not being able to pay.
While I still don’t like the idea of walking away from the mortgage I do feel it’s a little more understandable in those cases. What I’m talking about today is the homeowners who are simply upside down with the loan-to-value ratio but are still fully capable of making the payments.
Last year I had a conversation with a local banker who confessed off the record that he felt these homeowners were doing the right thing. I’m not so sure I agree with him. I mean, I understand that it really stinks to have a mortgage that’s tens of thousands of dollars more than what the house is worth, but is it worth walking away from it?
The financial impact of walking away
Let’s look at the ramifications. First, your credit score will be trashed. Now, I’m not all that in love with the credit score since I don’t borrow money but if you’ve got an established credit history there’s no reason to intentionally damage it. Doing so will limit your options for borrowing in the future (not necessarily a bad thing) but it may also impact your insurance rates, future job opportunities, rental opportunities, and more.
Secondly, the bank may choose to come after you for any losses they experience. Let’s say you owe $250,000 on a house that’s now worth $175,000. If you simply walk away from the situation the bank will repossess the home. They don’t want to be in the real estate business so they will try to get rid of the house as fast as possible. So they’re likely going to sell it for less than $175,000.
Even if they get the full $175k, they’ve still loaned you $250k, resulting in a shortfall of $75,000 which is now gone and not recoverable by selling the house. Where are they going to go to get their $75k back? They’re going to sue the former homeowner and win a judgment against them.
Is walking away ethical?
So financially and legally it’s not a good idea to just walk away from your payments. Morally and ethically it’s a bad idea as well. You signed the contract agreeing to the terms of the mortgage. It didn’t have an escape clause based on the market value of the house, and you knew that.
You also knew in the back of your mind that it’s a significant commitment to sign a contract locking you into a large payment every month for 30 years. But you convinced yourself that there was no risk because “the price of real estate always goes up.”
Alas, now that things look a little bad you want out of the deal. You really didn’t mean what you said about making every payment for 30 years. After all, who keeps their word anymore these days? What an antiquated notion!
The thing is, you’re still able to make payments. If your financial situation hasn’t changed, why would you need to walk away from the house? Why not continue to pay as agreed and own up to your responsibilities as an adult borrower? If you suddenly don’t like those responsibilities, use this situation as a learning opportunity and move on. But please don’t make the housing situation worse by adding another vacant house to the already flooded inventory of homes on the market.
Locking in your losses
Plus, walking away from the house at the bottom of the market locks in your losses. The loss is only on paper until you lock in the losses by getting out. Kind of like when everyone watched the stock market tank in 2008, then panicked and sold out at the bottom. That locked in their losses. Now they’re still waiting for the market to come back up before they get back in. Problem is, it’s already come back most of the way. So those who got out lost out.
I don’t know what the housing market will do in the next few years. But I do know that every market is cyclical, so it will eventually come back. I just don’t know when. It could be next year. It could be ten years from now. If I were upside down on my house today, I’d rather take my lumps and pay down the equity so I at least still have a home, and when the market rebounds I’ll have equity in it again.
I think it’s just plain wrong to walk away from an agreement you made in writing or otherwise when you have every means to make good on your commitment. I think it’s time we start owning up and stop looking for the easy way out. That’s just my humble opinion. What do you think? Am I way off base or right on track? Leave a comment to let me know what you think.