Should You Pay Your Mortgage

Roger Lowenstein has written one of the best articles I have read on the topic: walking away from your house. The prominent author and journalist published a January 7, 2010 article in the New York Times with the headline, “Walk Away From Your Mortgage!” Lowenstein acknowledges that it may be financially careless for homeowners who are upside down on their mortgage to keep paying it in order to hang onto a fantasy of ownership and avoid the shame of default. In this article, Lowenstein’s subject is the borrower who can afford to pay the mortgage but considers opting out for reasons of financial benefit and survival. This is referred to as a strategic default.

Lowenstein’s thesis is exactly what I have been preaching to family, friends, and acquaintances for some time now. Many Americans are, by nature, very meticulous about paying off their debts and honoring contracts. Nevertheless, when they are stuck with a home that is worth far less than what they owe, the home becomes a noose around their neck, a pecuniary black hole, and a drag on household cash flow. It becomes what I call exorbitant rent. If the difference between the mortgage balance and the current market value is substantial, the homeowner is throwing away money on a home when it may take him years of mortgage payments to recover enough value to revert to a state where equity crops up. Thus the homeowner is essentially throwing money into an unpredictable black hole. If the mortgage payment is higher than a rent payment would be on a similar home, that adds the burden of overpayment for the “privilege” of being a quasi-homeowner paying high rent on a house you may never own, unless you plan to stay put in the house for a long time. If the mortgage is lower than an equivalent rental, there may be some advantage to hanging on for the short term, but that would depend on the condition of the house and various maintenance factors, as well as the additional costs of ownership.

After all, ownership requires payment for taxes, higher insurance (higher than renter’s insurance), and maintenance/replacement costs. I have gone over household budget/cash flow analyses with a few friends and family, and I have shown them the astounding cost differential between ownership of their “underwater” mortgage and renting a similar home. Yet people still aren’t willing to give up the cash-eating arrangement. Though I can spot the financial detriment, as a Certified Public Accountant I am very wary about giving direct professional advice, except to family – they know, perhaps too well, that I am never short of “pointers” for their financial situations. I refrain from telling people they “should” do this or do that because I don’t want to be blamed for someone’s unhappiness or other quality of life issues that may be the result of complex decisions. But I do try to make clear the alternatives to standing on the deck of a sinking financial ship. As Lowenstein remarks:

And given that nearly a quarter of mortgages are underwater, and that 10 percent of mortgages are delinquent, White, of the University of Arizona, is surprised that more people haven’t walked. He thinks the desire to avoid shame is a factor, as are overblown fears of harm to credit ratings. Probably, homeowners also labor under a delusion that their homes will quickly return to value.

I agree on the second point – almost all people are delusional and think the post-bubble housing crash is the aberration, and that the housing market will return to normal one day in the (near) future. They do not understand that the bubble was the aberration, and those days are over and dead. They thought the bubble prices were the new norm. And the strange thing is that they liked it. They delighted in receiving a high price for their home, and never seemed to be able to factor in the reality that they would also pay a higher price for another home. Not understanding the bubble is a principal part of the problem in getting those people to understand the whole of their financial problem. Also, people do indeed desire to avoid default and they fear the effect that a poor credit rating will have on their future. I agree with Lowenstein that most credit rating fears are a bit overblown, and besides, it is far less problematic to absorb the short-term trauma from a shoddy credit rating and radically improve your long-term financial prospects while shedding the iron monkey on your back.

The other snag is that most individuals, no matter how "educated" they may be in the college sense, are financially ignorant and cannot conduct basic analyses of their own financial matters, let alone weigh the costs and benefits of a complicated scenario. There are plenty of talented and smart people who don’t have the skills to sort out budgets, expenses, debt, and investments. That is not a criticism – it is just a fact. Furthermore, add to that the fact that the boom years produced rabid consumerism, and keeping up with the Joneses become a core family value for so many debt-worshipping Americans. The gotta-have mentality destroyed what common sense that would have otherwise emerged.

Enter the typical, boom-period mortgage representative, a guy who also knows nothing about business, finances, or accounting. He was most likely hired as a short-termer, with no experience in the business – he was hired for his sales ability and arm-twisting skills. Or he may have a college degree in finance, accounting, or economics, but washed out trying to make it those competitive fields. He was hired to help the mortgage company keep up with the demand generated by the housing bubble, and he knows nothing more than what he was taught in his introductory training that focused mostly on seduction skills and reaching sales goals. Those people sense the gotta-have desperation and they pounce on the vulnerable would-be borrower. ARMs and interest-only loans became a new middle-class norm, which amounted to certain disaster for the person who became a homeowner during the bubble. The natural human instinct for handling undesirable affliction is to get rid of the offending parasite and make things right as quickly as possible. This is your moral duty to yourself, your family, and your future. Moreover, Lowenstein makes this point:

Former Treasury Secretary Henry M. Paulson Jr. declared that "any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator — and one who is not honoring his obligation." (Paulson presumably was not so censorious of speculation during his 32-year career at Goldman Sachs.)

Federal officials like Paulson, along with others who have in interest in keeping you hogtied to the sinking housing market, are trying to depict struggling Americans as irresponsible scoundrels who are rashly walking away from their commitments. Various political special interest promoters and academics that pontificate from outside of the real world that the rest of us live in are reflecting that view. George Brenkert, a business ethics Professor at Georgetown on the Potomac, was quoted in the Wall Street Journal as saying "borrowers who can pay – and weren’t deceived by the lender about the nature of the loan – have a moral responsibility to keep paying." A follow-up quote from the article states this:

A standard mortgage-loan document reads, “I promise to pay” the amount borrowed plus interest, and some people say that promise should remain good even if it is no longer convenient.

But, like Lowenstein says, the borrower signs a promissory note and "the contract explicitly details the penalty for nonpayment — surrender of the property. The borrower isn’t escaping the consequences; he is suffering them." Lowenstein also places some blame, as he should, on those folks in the mortgage industry who took full advantage when government-created bubbles made their businesses bloom, and now they are on the defensive when debtors are looking to escape the wrath of the bloody aftermath.

But to put the onus for restraint on ordinary homeowners seems rather strange. If the Mortgage Bankers Association is against defaults, its members, presumably the experts in such matters, might take better care not to lend people more than their homes are worth.

In the same Wall Street Journal article noted above, John Courson, Chief Executive of the Mortgage Banker’s Association, lowers the boom on the bogged-down buyer and asserts the guilt game:

But it isn’t just a matter of the borrower’s personal interest, says John Courson, chief executive of the Mortgage Bankers Association, a trade group. Defaults hurt neighborhoods by lowering property values, he says, adding: “What about the message they will send to their family and their kids and their friends?”

This is the same corporate state-special interest slimebag who lobbies feverishly for favors from the feds so his mortgage industry clientele can profit handsomely and the taxpayers can foot the bill by bailing out companies that fund his industry, such as Fannie Mae and Freddie Mac.

Then there’s Megan McArdle over at The Atlantic – someone who has the financial wherewithal of a lobotomized cadaver. Megan rants about deadbeats who don’t pay their debts and instead choose bankruptcy as an easy way out of an accumulation of bad decisions. Indeed, my article and blog archives are loaded with invectives on this very same topic – few people have written as much criticism as I have about how hare-brained, high time preference Americans have gone wild on consumer spending and debt, thanks to the Federal Reserve’s funding of the credit bubble and other economic factors that all trace back to Big Government and its corporate state compadres. I have never absolved these impetuous debtors from their role in perpetuating their own problems because they could have chosen to abstain from the spending frenzy mentality.

However, Megan cites the same Wall Street Journal article, and she is confused because she doesn’t draw the distinction between those who go on a reckless debt-o-rama spree and walk away from the financial carnage, and mortgage debtors who are underwater due to the breakdown of a completely unsustainable economic system. If McArdle had any business sense, she would understand that strategic defaults are a conventional business practice. Throwing good money after bad just isn’t an option, either for a corporation trying to maintain a brisk bottom line or an individual who needs to keep his financial house in order. Daniel Gross recently wrote an article in Newsweek titled "Default Nation," where he discusses this very fact, including the mention of recent strategic defaults by Stanley Morgan, KKR, and Six Flags, a company where Bill Gates has 11% ownership. Mr. Gross writes that it is surprising that, given market conditions, there aren’t more consumer defaults.

Let’s return to Roger Lowenstein, where he reveals, "We are all economic pinballs, insensibly colliding for better or worse." What Lowenstein doesn’t say is that individual mortgagers are not responsible for the credit bubble, the housing bubble, or the unsustainable and corrupt federal policies that encouraged and fueled the speculative boom and bubbles. The economic meltdown and ensuing fallout in housing values has been a recipe for financial disaster for many households, and each individual or family must commence a course of action that is sensible, sustainable, and provides for long-term financial security and growth. It is not unethical or immoral to relinquish a strangling and injurious debt load on a house that ties you down in favor of mobility and a healthier household financial plan. In fact, it is state worship and economic ignorance that fuels the notion that you, as a victim of the state and its corporate state special interests, have some obligation to ruin your life and bend over to "take one for the team."

If all factors point to your best option being a default, then walk away guilt-free and boost your cash flow and future prospects, because ultimately, you are responsible for you, and none of these babbling naysayers are going to bail you out or come by to help clean up the mess. Walk away, free yourself from unnecessary bondage, and let the giant banks sort out the mess that they helped to perpetuate and swell.

January 11, 2010

Karen DeCoster, CPA [send her mail] is a libertarian accounting/finance professional and writer. She was writing about rabid consumerism and debt, the housing bubble, corporate bankruptcies, boom-period business malinvestments, and the economic crack-up long before it was fashionable. She likes to occasionally look through the piles of hate mails from those times while sipping on an Oregon Pinot Noir. This is her LewRockwell.com archive, her Taki’s Magazine archive, and her Mises.org archive. Check out her website and blog.

Copyright © 2010 Karen DeCoster

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