The Ethics of Voluntary Mortgage Default

Friend and reader Loren Platzman alerted me to the article, “Walk Away From Your Mortgage!” in the Sunday Times Magazine ( the magazine was, in fact, sitting unopened by my desk at the time. Some days, I just know that reading Randy Cohen’s “The Ethicist” column is going to ruin my weekend.) The thrust of the article, an installment in the “The Way We Live Now” series, is that American cultural tradition has reinforced the belief that there is something unethical and shameful about voluntarily letting the bank foreclose on a property when falling property values have placed the mortgage “under water,” meaning that the home is worth less than the amount still owed on it. In such a dilemma, walking away from the mortgage is a rational course, but it involves intentionally failing to meet the obligations of the mortgage contract. A contract is a promise. Breaking a promise is wrong.

The author, Roger Lowenstein, argues that the supposed  moral obligation is, essentially, a trap that benefits the bankers. He points out that loaning institutions routinely “walk away” from contractual obligations of their own when the penalties for default are less than the pain of paying. Lowenstein’s arguments in favor of abandoning bad mortgages boil down to two classic rationalizations: “everybody does it,” everybody in this case meaning financial institutions, and “they deserve it,” meaning that nobody should feel obligated to treat banks any more ethically than they treat everyone else. Both are ethically invalid. We have ample evidence that financial institutions have behaved incompetently, irresponsibly, unfairly and often dishonestly. That doesn’t make such conduct ethical or just, even when it is turned against them. Lowenstein’s theory is that we should let banks set the culture’s ethical standards.

Yikes.

His conclusion that it is not unethical to default on a mortgage, however, is correct. There is nothing unethical about giving up the property when completing the contract becomes both a hardship and financially illogical. As the article notes, mortgage contract and loan agreements include the penalty for default; it is anticipated by both parties in the contract, and is a part of the contract. The bank will foreclose on an involuntary mortgage default, in most cases, with nary a thought about the hardship to the homeowner and the family, nor is it ethically obligated to have such thoughts, for its first duty is to its investors and shareholders. Similarly, it is ethical for the homeowner whose mortgage is “under water” to use the foreclosure option in the best interests of those who depend on him or her: family members and other creditors.The bank is provided for in the contract. In the event of default, it gets the house.

Some might argue that sticking out a bad deal despite all hardship is the most ethical course. I might agree, just as it might be the most ethical course for failing businesses to sell off every asset and for their owners to indenture themselves to creditors rather than to declare bankruptcy. Not following the most ethical course, however, isn’t the same thing as being unethical. Balancing ethical and non-ethical considerations is an essential part of life, and learning to do it rationally and fairly is a life-long quest.

Yes, our word should be our bond, we should keep our promises, and those who keep promises that no longer make sense deserve our respect. But as with the woman who finally broke her promise to her late husband to have him lying for eternity over the resting place of Marilyn Monroe, there are times when breaking a promise is reasonable, fair, and ethical.

Defaulting on an under-water mortgage qualifies.

Now I guess I have to go read Randy Cohen….

17 Comments

Filed under Business & Commercial, Daily Life, Journalism & Media, Law & Law Enforcement, Religion and Philosophy

17 responses to “The Ethics of Voluntary Mortgage Default

  1. Lianne

    If the homeowner can afford the existing mortgage payment without financial hardship — i.e., a homeowner who has not lost his / her job or had a reduction in income — but just doesn’t want to be “stuck” with a home that is now worth less than when he / she bought it, I think that homeowner has an ethical obligation to fulfill his / her terms of the contract and pay up. Sorry about your luck. When my first house lost 30% value in the first year, we sucked it up, paid the mortgage, and didn’t sell until it was once again worth what we paid — 12 years later. It wasn’t fun and we were annoyed (and scared, for most of that 12 years), but we could afford it. Now our second home is surrounded by people who purchased their houses at the peak. (Half a million dollars! For a 30+ year old basic house in Manassas! Ha!!) It’s OK for them to walk away, leave the house vacant for months and months, and buy something cheaper somewhere else, with no impact on their credit? Sorry, I can’t agree with that.

    • Michael

      I have to agree wholeheartedly with Lianne. When your investment works out, you keep the profit, but if it tanks (even temporarily) you shift the loss off to somebody else. How can that be ethical? It may be legal, but it can’t be ethical. Who pays for that loss? I do. I didn’t buy an overhyped, overpriced house and now I am going to see increased bank fees, lower interest on my savings account, and increased taxes to bail out the mortgage companies and insurance companies who have to cover their losses. How is hurting other people to maximize your profits by breaking a contract ethical?

  2. The question is, what’s “financial hardship”? The divide isn’t between “can’t pay the mortgage no matter what” and “Can pay the mortgage just fine, thanks.” How about, “Can just barely pay the mortgage while living like a pauper and skimping on health care, education and other basics”? Should people in THAT situation feel guilty about walking away?

    Walking away, by the way, is hardly maximizing profits: it’s a loss, a total loss. It is an attempt to minimize loss. The bank has, up to the forfeiture, made money on the loan. And I repeat: foreclosure is mentioned in the contract…it is part of the deal.

    • Michael

      I have been watching the media tell people to walk away from the loans if they are “underwater” for six months. They have never been talking about people who couldn’t afford the loans. If you reread the article, you will see that they are talking about VOLUNTARY foreclosures. These are not people who can’t afford the monthly payments by any reasonable definition of “financial hardship”. Not being able to buy a fourth vacation home now does not fall under my definition of “financial hardship”.

      •These people put little or no money down, so they have nothing to lose. They have effectively been paying the mortgage company “rent”.

      •They are just upset that their investment (the house) has now lost money. The “underwater loan” issue has been treated separate than the foreclosure issue for just this reason. They want out BEFORE they lose money. They bought a house for $700,000 that is now worth $400,000 with no money down. They don’t want to pay $700,000 for their $400,000 house.

      •Foreclosure stipulations are like prenups to a marriage. Most of us aren’t attorneys. We see a divorce as breaking the marriage contract even if a prenup (describing what will happen if the marriage contract is broken) is included. We see refusing to pay a mortgage just because the house has depreciated as unethical. It was not what that foreclosure stipulation was in there for. Again, I didn’t say it was ILLEGAL, just unethical.

      •I will never be able to see how it is ethical to hurt others to escape the financial repercussions of your bad investment, especially losses that you could afford.

  3. Even with nothing down, you have some equity in the house after six months. You have an awfully narrow definition of “voluntary.” I take it, in the article and elsewhere, to mean “you have the option NOT to.” You didn’t answer my question: is your result different if the “voluntary” walk is to avoid expanded financial stresses elsewhere?

    I have to say, I wasn’t even thinking about the casual, what the hell walker.

    Your analogy with a pre-nup is interesting, however. You really regard resorting to a pre-nup as unethical? Because walking away from a marriage is almost always “voluntary.”

  4. Personally, I think breaking a contract that is not unfair on it’s face is always unethical. It may not be the least ethical course of action, because of the ethical conflicts that may arise (i.e. what is more important — living up to your contract or providing food and health care for your family?), but I don’t believe you can ever ethically “just walk away” absent much more than just a minor financial inconvenience.

    I buy and sell things for a living. When a supplier fails to provide the service I contracted for, I consider it a black mark against him. Yes, the contract of purchase “contemplates” the possibility of a failure to perform for both parties and provides remedy for breach, but that failure may impact my business — I may have to buy from another supplier at a loss, or have to void the order to me. Both carry additional harms that are not suffered by the vendor — loss of reputation and loss of profit that I spent time working for, among others.

    In the mortgage case, the damages for default are different, but if they were in and of themselves sufficient, why would lenders consider it a “bad” thing, and reduce the defaulter’s credit rating? This is not contemplated in the mortgage, but is implicit in it. Clearly, the mortgage contract does not contemplate market valuation fluctuations that may make it financially inconvenient for the buyer, but does that make it right for the buyer to simply slough off those unforeseen fluctuations on the lender by way of default?

    So yes, it can be ethical, on balance, to walk away from a mortgage. But in my humble opinion, it requires a careful balancing of the equities, and simple financial inconvenience due to a temporary market fluctuation is not, in itself, enough to make it ethical.

  5. A tangential comment: to call a mortgage loan contract between an individual homeowner and a financial institution “fair” is a necessary fiction. The bargaining positions are so unequal that the terms always favor the lender in the extreme, though the lender is in the least vulnerable position. If a mortgager is late with a payment, there is cash penalty. If the lender is late posting payment, as has happened to me many times, there is none. Dozens of examples of similar inequities.

    Is NBC unethical for “walking away” from its contractual promises to Jay Leno and Conan O’Brien, when the value of their current shows no longer were worth what their guaranteed contracts paid? They are abandoning ship and accepting the penalty of a deal that didn’t work out.

    • Michael

      The NBC deal is ethical if Leno, O’Brien, and NBC all agree to the breaking of the contract of their own free will (doubtful in O’Brien’s case). In the foreclosure deal, it is a one-sided case. The ‘contract’ is supposedly between the homeowner and the bank. If the bank took the loss on its bad decision to loan such a short sighted opportunist the money and compensated by selling bonds, cutting dividends, not awarding $500,000/employee in bonuses, not giving raises, then yeah, I would call it ethical. This is not what is happening, however. The loss is being borne by the U.S. taxpayer. The U.S. government (or it’s subsidized corporations) are buying up these ‘toxic assets’ and taking the loss. I have to pay because they don’t want to wait around for the market to appreciate (which it will in 5-10 years) or face the fact that they made a bad investment.

      If NBC broke its contract with Leno and O’Brien and convinced the federal government to charge the losses it incurred on the decision to ABC, CBS, and Fox, through higher FCC fees, would it still be ethical?

      How much has the property in California depreciated in the last 2 years? A 50% depreciation in residential homes in California alone would be about twice the federal government’s budget. What about Florida? Who is supposed to absorb the loss for that much depreciation? What would happen if all of those people “voluntarily foreclosed”?

      • Agree? They don’t have to agree—NBC “owns” them. They just thought they had been promised their shows long enough to establish themselves. and NBC wouldn’t wait, much like an under-water home-owner not being willing to wait for his investment to turn around.

        The home-owner is not obligated to take responsibility for irresponsible lending practices by the banking industry, terrible regulation by the Feds, and a dubious decision to make tax-payers pay for industry mistakes.
        A properly-run financial institution would be usually be able to convert a walk-away at no loss at all. You are putting all the fault—on one walk-away homeowner! And the “what if everybody—?” argument is dirty pool. What if everyone stopped buying homes at all? Would that make me unethical for choosing to rent? If everybody started walking away, the law would adjust to discourage it.

        There are certain things a homeowner could do that would make walking away unethical. Trashing the property, for example—actively reducing an asset that you aren’t keeping. (I haven’t researched this, but I would think that would sustain a lawsuit.)

        There was never any anticipation in these mortgages that any loss would be born by taxpayers. That is the case because those taxpayers voted for the elected officials in charge. That can’t be laid at the door of the borrower.

  6. Pingback: More on the Ethics of Voluntary Mortgage Default. « ReReno's Blog

  7. Tim LeVier

    I’m going to lay out some ideas, or better yet, lessons learned from this meltdown:

    1) Mortgage companies should only loan money to cover a stripped down home. I think a home that has a 90% mortgage of sale price value is not leveraged properly.

    2) Homeowners should be able to walk away from their home at any time because they signed a contract that said, “You can walk away, we just take your home.” If mortgage companies continue to allow this, they should see #1 above.

    3) Investors in mortgage companies / securities should know the risks involved in such investments.

    D) O’Brien sucks, and the Tonight show hasn’t been relevant for years. The Leno Show was a return to Johnny Carson type of variety show. Now Leno will go back to the Tonight Show and be used as a glorified ad spokesman again.

    • 1. Agreed.
      2. Agreed.
      3. Agreed.
      4. Irrelevant, though. O’Brien doesn’t suck, but his Tonight Show sucked thus far. He would have gotten it right eventually, or at least better. I think he’s the wrong guy for that show, but never mind: he still was fair to NBC, and they double-crossed him.

      • Tim

        I just tried Lopez Tonight for the first time…I know I’m younger than you, so it may not be for you, but I thought it was amazing and awesome. This is the natural successor to the Tonight Show, but if it existed on NBC, it wouldn’t be the same.

  8. The lenders have built in a figure for defaults and foreclosures. The problem is that strategic defaults are occurring at a faster pace and in greater numbers than bargained for.
    The question I have for lenders is “how much of your loss is covered by insurance?”. So the situation could be much worse for the insurer.

  9. Dennis

    Our situation, like some others, was different. We were victims of preditorial lending. This was the worst kind of unethical behavior we ever experienced. We were blinded by the “dream house effect.” Within two years after closing were filing for bankruptcy. We felt so violated and still have mixed feeling about how they got over on us and what to do about it. We have this well documented. Any lawyer willing to take a case in PA…? Contact us.

  10. bonju

    Our situation is this. We live in NJ and my partner is on straight medicaid. The state of NJ – Gov Christie is switching Straight medicaid out to an HMO – he’s farming it out until “obamacare” kicks into the state and infuses those programs with more money. My partner will lose her doctors and gain new ones (maybe) medicaid cannot answer these questions.

    I went Chapter 7 last year and have a voluntary mortgage and just lost another client sealing my fate in NJ. I am exhausted trying to find work in NYC and not getting a full time offer only part time with p/t clients who are insane and don’t want to pay my rate always jewing me down for less.

    In another state I will have access to medicaid myself since I am not working, I will have access to a house that my family owns and is living in, I will be with my partner and her family who are living in the house now. I will be able to find work.

    I will not indulge in a short sale and I will leave the house to the bank who so greedily sold us the house and have done nothing to help us. Last year I ref’d at a lower cost and when I chaptered the cost stayed where it was with repeated requests from the bank to get back on the loan, which I did not do on the advise of my lawyer.

    We are leaving – I cannot sell the house for what I bought it for and will take a loss and owe the bank – short sale is not for me – we put in too much work and money and got nothing out of it. I am the only breadwinner and am tired of this horrible american nightmare. There was no dream in home owning believe me and if you still think that there is – you go buy a house. I hate it – My name will never appear on another deed ever.

    We walking and happy about it. Screw the chinese. Screw HSBC bank – hope they go under like all the rest – we bailed them out and they don’t care about us. Screw them and screw all of you who think otherwise.

  11. bonju

    BTW TIM above wrote that banks have the right to take your home and foreclose on you if you can’t pay the mortgage. b/w the property taxes (so high) and the mortgages and interest rates sky high it is virtually impossible for a small business like mine to do well. It’s a prescription for failure and while we are both terrified to move to something unknown it is better than this alternative where we know we are going to get screwed. Better to move in the summer than suffer in the winter -

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