People who treat their homes as investments should remember that, should the investment completely lose value, it's reasonable to cut their ties and take the loss, not continue to take losses on it indefinitely.
That is to say, it is an investment, and should be treated appropriately as one.
If your house is a home rather than an investment, you can ignore this suggestion ;-)
Disclosure: I have a mortgage, but it's not underwater and is doing just fine.
Right, there are non-investment related values to a house for most people. Kids friends in the area, nice neighbors, the landscaping you did last year, etc. So even if you couldn't sell and recoup your mortgage, doesn't mean the value of your house is worth walking away from.
On the other hand, investment properties are almost entirely dollar based. Which is why (in theory), banks require a higher down payment on them - to get you invested.
Just in case anyone knows.. why are mortgages in the US structured in this lax way? In the UK, if you don't pay your mortgage, you're still entirely liable for the debt even after handing the keys back. If you can't meet the difference between what they make on a quick sale and the owed amount, they will, and do, bankrupt you over it.
As the article noted, mortgage contracts in the US stipulate the penalties for walking away, and those penalties go no further than surrendering the house.
Exactly. And as the house is the collateral for the loan, that makes perfect sense. If the bank was dumb enough to write a loan that they can't get back by selling the collateral, why should the borrower be expected to bear the burden? Frankly, I like the US system; it places the burden of analyis and risk management on the party most able to do that competently.
Except that's more like a hire purchase agreement than a loan. If you take a bank loan to pay for a car/boat/to fund your startup/whatever and you can't pay it, you're still on the line for the loan if the assets purchased can't match the capital owed. Mortgage loans seem to be treated as a special case in the US.
True, though there are loopholes there too: startups are almost universally corporations or LLCs, generally for the express purpose of insulating the owners from the liabilities of the business. And banks routinely write off uncollectable car loans by selling them to collection agencies; they aren't large enough to bother with enforceable legal action.
The homeowner protection laws are the same kind of thing. As a society, we decide that home ownership is worth encouraging (whether that's true or not is an interesting side question), so we implement policy designed to encourage it.
They are not breaching the contract. The contract says they can walk away any time, but they lose their house. A full recourse mortgage (where you don't have the option of walking away) must be illegal, otherwise the banks wouldn't put such a clause in their contracts. (I don't know, I'm not a legal eagle).
The system you describe puts 100% of the onus of appraisal onto the borrower. It's in the bank's best interests to inflate the value of the home as much as possible and get a borrower on that inflated amount, because now, regardless of what the property is actually worth, the borrower is on the hook for the full amount.
The bank is normally the one who approves the appraiser, which is a clear conflict of interest. In our system, ideally everyone is best served when the appraiser is neutral and competent because the borrower doesn't over pay, and the bank isn't exposed to much risk since the collateral can actually cover the obligation.
The system you describe has a huge loophole because lenders hold all the cards and could easily collude on the sly with appraisers to drive prices up at the expense of the individual. It wouldn't even need to be an explicit collusion -- sort of like the default swap stuff, no individual player (who could see that the system was a sham) had any incentive to bring it down. On the contrary, they had incentive to keep up the bullshit in order to make their numbers. A similar pressure could result with laws that heavily favor the lender.
There is a possible upside to the borrower for an inflated valuation too.
As long as the market is rising the borrower can point to the increased valuation since the property came on the market and use that to 'pass the hot potato' to the next sucker.
Plenty of people made tons of money in this way in the '96 to 2000 period, especially in larger cities where property prices tend to go up out of proportion.
"The system you describe has a huge loophole because lenders hold all the cards and could easily collude on the sly with appraisers to drive prices up at the expense of the individual."
That happens here in the US. Appraisers I've talked to have been pressured to raise the value of the property, so the transaction will happen. The seller wants to sell it for X. The buyer wants to buy it for X. The two agents and the bank want the house sold for anything at all.
Buyers and sellers should choose and pay for their own appraisal, even if the bank requires the buyer to pay for an appraisal for the bank.
Lenders typically lend up to a maximum % of the purchase price - 90% is typical.
So if you default on the loan, they'd have to sell it for less than 90% of the value for you to owe them anything on it. If you default though, it's their home, they're free to sell it for whatever they like.
As far as the actual house sale goes, the bank/lender has little/no power in the UK. If they don't want to lend the money on the house there are others that will. The price is decided by the seller/estate agent, and the obviously the buyer. The main critera the bank has is that you pay a % of the purchase price - they'll lend typically only up to 90%-95% or so.
I like the UK system personally. I think it's responsible. Not to mention the silliness of yearly home tax?! in the US and other craziness.
It depends on the state. In most states the bank can go after you in court. But California is an exception, and it also happens to be the state that had the biggest bubble.
> It depends on the state. In most states the bank can go after you in court. But California is an exception, and it also happens to be the state that had the biggest bubble.
CA's exception only applies to the purchase mortage. If you refinance, that lender can go after you for the difference.
Note that you owe federal income taxes on forgiven debt. I suspect that most states with income tax do the same.
The article says that fears of damage to your credit rating, if you do this, are "overblown". But surely the damage to your credit rating among rational creditors should be really severe?
If I were a bank and I found out a borrower had walked away from a previous loan leaving their creditors holding the bag, there's no way in hell I'd lend them a single cent, ever.
And people are complaining that the crash was caused by under-regulation? How about first removing all the laws which force banks to lend money to folks who are unworthy of credit?
Do you apply your indignation to bankruptcy to all cases? After all, bankruptcy is used strategically in business situations by everyone from General Motors, to airlines, to Donald Trump who usually come back with even larger undertakings, and often with more profits.
Yeah, and let's bring back debtors prisons while we are at it...
The general idea of these laws is that 7-10 years is a long-enough window into a persons financial state and habits to determine their current credit-worthiness and limiting this look-back window prevents lenders from subverting the purpose of US bankruptcy laws. There are no laws that force banks to lend money to people, only laws that limit the duration of certain items on your credit record.
Prior to 2007, the majority of Bankruptcies in the United States were a result of medical bills. Without socialized medicine, and a leaky private insurance system, getting seriously ill in the United States basically wiped you out financially.
This is actually one thing that I've never been able to make people from countries that have socialized medicine believe.
The sheer _concept_ of an illness wiping you out financially is typically beyond their comprehension. Most people in the United States without that experience also have a tough time understanding it as well.
Suggesting people can never get a reasonable loan because of a bankruptcy, and therefore likely because of an illness, is a little much.
You do maintain a running credit record that should accurately reflect your (illness free) creditworthiness.
(Disclaimer: I'm a Canadian working Silicon Valley with excellent medical insurance who has never had a hospital stay or need to call on said-insurance (knock-on-wood))
> Prior to 2007, the majority of Bankruptcies in the United States were a result of medical bills.
Not so fast.
The "study" that supposedly found that actually didn't. At most, it found that folks who went into bankruptcy had medical bills. They also had car payments, house payments or rent payments, and so on.
When you're going broke, bills for everything start piling up.
They'll have trouble getting another mortgage, that's true. But that's surmountable if you're happy with renting and/or can find a co-signer for your loan. Similar things are true for automobile loans.
But generally when people talk about "damaged credit", they mean an inability to get a credit card. And there, I'm willing to bet there are plenty of banks willing to do business with people with foreclosures on their records. The revenue model for credit cards is based on fees, not loan risk.
Many have and will continue to have their homes foreclosed during this recession, and they will have "bad credit" for a long time. If/when the economy turns around in a few years, any bank that decides to not fund these same peoples' mortgages the next time they shop for a house will miss out on a huge piece of the market. The banks won't stick to this policy. They'll follow the credit card companies who are very eager to issue new cards to those who just finished their bankruptcy proceedings.
The funny thing is that folks who are deeply underwater on their mortgages are _already_ screwed with regards to credit - even if they have a good credit history and are up to date on all payments. I know someone who has high 700s credit score that was recently turned down for a credit card, the reason given was that the balance on their mortgage was too high. That was the straw that broke the camel's back for them and they have decided to do a short sale on their property.
That makes no sense. Being underwater doesn't mean that your mortgage balance is too high, it means that it's higher than the value of the house. A credit card company would have no way of knowing the value of the house unless they had an appraisal done. What they likely meant was that either the balance or the monthly payment (or both) was too high for his income.
I understand what "being underwater" means - thanks though. The facts are that the credit card companies don't need to do an appraisal - the entire market where this person lives is down 50% from the time they took out the mortgage. The person maintains a good income and can easily pay the mortgage payment, it just doesn't make sense any more for them to throw good money after bad to hold on to a FICO score that really doesn't get them credit any more.
Again, you're not making any sense. Let's say the mortgage that the person has is for $250,000. How does the fact that my market has supposedly lost 50% now mean that my mortgage is "too high"? Perhaps the house was worth $1m when I bought it and is now only worth $500k. Would the credit card company still think the mortgage is "too high"? It's still only 50% of the value of the house. I think you're missing some data.
It makes sense because the borrower has gone from having a positive net worth to a negative net worth due to the mortgage being underwater.
When they took out the mortgage, they were debt-free and had a mortgage equal to the value of their assets (the 1 million dollar house balances out the 1 million dollar loan), giving them a net worth of essentially $0. Now the house is worth $500,000 (but they still owe $1,000,000), so their net worth is essentially -$500,000.
Under these circumstances, it makes sense that the credit card company doesn't want to issue a card to someone that they know is worth negative a half million dollars, even if he did pay all his bills on time and can make the monthly payment on the amount he owes.
From my earlier post : "the entire market where this person lives is down 50% from the time they took out the mortgage".
The building they are in was built in late 2005 in downtown San Diego. It doesn't take an appraisal to know that it's underwater - there are many short sales and foreclosures of identical units that can attest to that fact. If anything it's easier for the credit card company to see the mortgage balance then it is for them to see someone's income as that does not go on the credit report.
It's the _balance_ on their mortgage (the amount they owe, not the amount of the mortgage originally) - that is the problem.
Likely the credit card company believes he lives at his billing address, and has done some geo-analysis of credit trends for mortgage holders in his area. Your credit record will indicate when you initiated your mortgage and what the terms were, and it's relatively straightforward to do risk analysis after that.
I've frequently wondered what impact having all my bills sent to Paymybills/Paytrust at Box 14814695, Sioux Falls, South Dakota for the last 10 years has had on my credit profile. :-)
As my father (A Real-Estate Developer/Mortgage Broker/Car-Hock moneylender) used to tell me:
"A loan that isn't backed with readily liquidated collateral should be considered a gift with no expectation of return"
Money lenders aren't stupid. They realize that anything that isn't covered with collateral is money that they have a 90% chance of losing. It's is utterly beyond them why _any_ borrowers would not consider walking away from an underwater mortgage once the ROI hit the sweet spot (Credit Record Hit, and possible law suits being two costs factored in)
The NYT article was an excellent summary of the issues though.
36 comments
[ 10.3 ms ] story [ 337 ms ] threadPeople who treat their homes as investments should remember that, should the investment completely lose value, it's reasonable to cut their ties and take the loss, not continue to take losses on it indefinitely.
That is to say, it is an investment, and should be treated appropriately as one.
If your house is a home rather than an investment, you can ignore this suggestion ;-)
Disclosure: I have a mortgage, but it's not underwater and is doing just fine.
On the other hand, investment properties are almost entirely dollar based. Which is why (in theory), banks require a higher down payment on them - to get you invested.
Any legal eagles around to explain how this is possible?
The homeowner protection laws are the same kind of thing. As a society, we decide that home ownership is worth encouraging (whether that's true or not is an interesting side question), so we implement policy designed to encourage it.
The bank is normally the one who approves the appraiser, which is a clear conflict of interest. In our system, ideally everyone is best served when the appraiser is neutral and competent because the borrower doesn't over pay, and the bank isn't exposed to much risk since the collateral can actually cover the obligation.
The system you describe has a huge loophole because lenders hold all the cards and could easily collude on the sly with appraisers to drive prices up at the expense of the individual. It wouldn't even need to be an explicit collusion -- sort of like the default swap stuff, no individual player (who could see that the system was a sham) had any incentive to bring it down. On the contrary, they had incentive to keep up the bullshit in order to make their numbers. A similar pressure could result with laws that heavily favor the lender.
As long as the market is rising the borrower can point to the increased valuation since the property came on the market and use that to 'pass the hot potato' to the next sucker.
Plenty of people made tons of money in this way in the '96 to 2000 period, especially in larger cities where property prices tend to go up out of proportion.
That happens here in the US. Appraisers I've talked to have been pressured to raise the value of the property, so the transaction will happen. The seller wants to sell it for X. The buyer wants to buy it for X. The two agents and the bank want the house sold for anything at all.
Buyers and sellers should choose and pay for their own appraisal, even if the bank requires the buyer to pay for an appraisal for the bank.
So if you default on the loan, they'd have to sell it for less than 90% of the value for you to owe them anything on it. If you default though, it's their home, they're free to sell it for whatever they like.
As far as the actual house sale goes, the bank/lender has little/no power in the UK. If they don't want to lend the money on the house there are others that will. The price is decided by the seller/estate agent, and the obviously the buyer. The main critera the bank has is that you pay a % of the purchase price - they'll lend typically only up to 90%-95% or so.
I like the UK system personally. I think it's responsible. Not to mention the silliness of yearly home tax?! in the US and other craziness.
CA's exception only applies to the purchase mortage. If you refinance, that lender can go after you for the difference.
Note that you owe federal income taxes on forgiven debt. I suspect that most states with income tax do the same.
If I were a bank and I found out a borrower had walked away from a previous loan leaving their creditors holding the bag, there's no way in hell I'd lend them a single cent, ever.
And people are complaining that the crash was caused by under-regulation? How about first removing all the laws which force banks to lend money to folks who are unworthy of credit?
The general idea of these laws is that 7-10 years is a long-enough window into a persons financial state and habits to determine their current credit-worthiness and limiting this look-back window prevents lenders from subverting the purpose of US bankruptcy laws. There are no laws that force banks to lend money to people, only laws that limit the duration of certain items on your credit record.
This is actually one thing that I've never been able to make people from countries that have socialized medicine believe.
The sheer _concept_ of an illness wiping you out financially is typically beyond their comprehension. Most people in the United States without that experience also have a tough time understanding it as well.
Suggesting people can never get a reasonable loan because of a bankruptcy, and therefore likely because of an illness, is a little much.
You do maintain a running credit record that should accurately reflect your (illness free) creditworthiness.
(Disclaimer: I'm a Canadian working Silicon Valley with excellent medical insurance who has never had a hospital stay or need to call on said-insurance (knock-on-wood))
Not so fast.
The "study" that supposedly found that actually didn't. At most, it found that folks who went into bankruptcy had medical bills. They also had car payments, house payments or rent payments, and so on.
When you're going broke, bills for everything start piling up.
But generally when people talk about "damaged credit", they mean an inability to get a credit card. And there, I'm willing to bet there are plenty of banks willing to do business with people with foreclosures on their records. The revenue model for credit cards is based on fees, not loan risk.
When they took out the mortgage, they were debt-free and had a mortgage equal to the value of their assets (the 1 million dollar house balances out the 1 million dollar loan), giving them a net worth of essentially $0. Now the house is worth $500,000 (but they still owe $1,000,000), so their net worth is essentially -$500,000.
Under these circumstances, it makes sense that the credit card company doesn't want to issue a card to someone that they know is worth negative a half million dollars, even if he did pay all his bills on time and can make the monthly payment on the amount he owes.
The building they are in was built in late 2005 in downtown San Diego. It doesn't take an appraisal to know that it's underwater - there are many short sales and foreclosures of identical units that can attest to that fact. If anything it's easier for the credit card company to see the mortgage balance then it is for them to see someone's income as that does not go on the credit report.
It's the _balance_ on their mortgage (the amount they owe, not the amount of the mortgage originally) - that is the problem.
I've frequently wondered what impact having all my bills sent to Paymybills/Paytrust at Box 14814695, Sioux Falls, South Dakota for the last 10 years has had on my credit profile. :-)
"A loan that isn't backed with readily liquidated collateral should be considered a gift with no expectation of return"
Money lenders aren't stupid. They realize that anything that isn't covered with collateral is money that they have a 90% chance of losing. It's is utterly beyond them why _any_ borrowers would not consider walking away from an underwater mortgage once the ROI hit the sweet spot (Credit Record Hit, and possible law suits being two costs factored in)
The NYT article was an excellent summary of the issues though.