[T]hough more than 34% of U.S. homeowners were underwater on their mortgages by the end of the third quarter of 2009, the strategic default rate was only 2.5% to 3.5% ... this pattern of relatively low default rates compared to the percentage of underwater mortgages has held true almost universally across the hardest hit markets, with the default rate much more closely resembling the unemployment rate than the percent underwater.
Millions of homeowners who bought homes in the last five years are in similar situations to Sam and Chris, particularly in the hardest-hit states of California, Florida, Nevada, and Arizona. For example, a homeowner who bought an average home in Miami at the peak would have paid around $355,400. That home would now be worth only $190,00037 and, assuming a 5% down payment, the homeowner would have approximately $140,000 in negative equity. He could save approximately $124,000 by walking away and renting a comparable home. Or, he could stay and take 20 years just to recover lost equity -- all the while throwing away $1300 a month in net savings that he could invest elsewhere. The advantage of walking is even starker for the large percentage of individuals who bought more-expensive-than-average homes in the Miami area -- or in any bubble market for that matter -- in the last five years. Millions of U.S. homeowners could save hundreds of thousands of dollars by strategically defaulting on their mortgages.
Homeowners should be walking away in droves. But they aren’t.
It might be tempting to label such underwater homeowners “woodheads"...but labeling such behavior irrational does little to explain its existence. ...
Alarmed by the possibility that foreclosures may reach a tipping point, formal federal policy has aimed to stem the tide of foreclosures through programs designed to "reduce household cash flow problems," such as the Making Home Affordable (MHA) loan modification program and Hope For Homeowners. Implicit in this approach is the assumption that homeowners are unlikely to default on their mortgage if they can "afford" the monthly payment. In other words, federal policy assumes that homeowners are -- for the most part -- not "ruthless" and won’t walk away from their mortgages simply because they have negative equity. Most homeowners walk only when they can no longer afford to stay. As evidence of this fact, only 45% of homeowners would walk even if they had $300,000 in negative equity. This percentage drops to 38% among the subset of individuals who believe it is immoral to strategically default on one’s mortgage (a subset to which 87% of homeowners belong)...
This is not to say that there is a grand scheme to manipulate the emotions of homeowners, or even that the government and other institutions consciously cultivate these emotional constraints on default. But, to be sure, the predominate message of political, social, and economic institutions in the United States has functioned to cultivate fear, shame, and guilt in those who might contemplate foreclosure. ...
At the political level, government spokespersons, including President Obama, have repeatedly emphasized the virtue of homeowners who have acted “responsibly” in "making their payments each month”115 and have lamented the erosion of “our common values" by, for example, those who irresponsibly borrowed beyond their means. The worst criticism has been reserved, however, for those who would walk away from mortgages that they can afford. Typical of such criticism is that of Secretary of the Treasury Henry Paulson, who declared in a televised speech: "And let me emphasize, 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 obligations."
Paulson's comment is mild, however, compared to the media invective toward those who strategically walk from their mortgages. Such individuals are portrayed as obscene, offensive, and unethical, and likened to deadbeat dads who walk out on their children, or those who would have "given up" and just handed over Europe to the Nazis.
There is similarly no shortage of moralizing about the responsibilities of mortgagors. Typical media messages include: "we need a culture of responsible consumers and homeowners;" "one should always honor financial obligations;" "when you enter into a contract that should mean something;" "there was a time when people felt really bad about not paying back debt," and, "money is more than a matter of numbers. There are ethics involved. Most people feel, or should feel, an obligation to pay their debts." Even sympathy for those who default because of predatory lending is frequently lacking: "We've read too many sob stories in the press about 'predatory lending' -- a rare, misunderstood, and vastly exaggerated phenomenon. It's time for the poster children for irresponsibility to get some face time."
Indeed, a homeowner contemplating a strategic default would be hard pressed to avoid the message that doing so would place them among the most despicable members of society. ...
Moreover, a homeowner who turned to any number of credit counseling agencies would also find little sympathy -- and much moralizing -- should they announce their plan to walk on their "affordable" mortgage. Gail Cunningham of the National Foundation for Credit Counseling declared for example in an interview on NPR: "Walking away from one's home should be the absolute last resort. However desperate a situation might become for a homeowner, that does not relieve us of our responsibilities." Indeed, the uniform message of both governmental and non-profit counseling agencies (which are typically funded at least in significant part by the financial industry) is that "walking away" is not a responsible choice and should be avoided at all costs.
What makes this moral suasion so effective is that major socializing agents in the United States tend to speak with one voice. Thus, when the government, or the credit industry, tells individuals that they have a responsibility to pay their mortgage even if they are seriously underwater, the message is seen as "echoing a deep-seated American belief that one should always honor financial obligations," -- and not as an effort to fix the primary burden of the housing meltdown on homeowners rather than the financial industry or the government. More critically, because the media and non-profit consumer counseling agencies promote the same message, the government and the financial industry need not bear the primary burden of moral suasion -- nor is the message ever identified with those political and economic institutions that have a vested interest in promoting "homeowner responsibility." The message rings true to the ear and, as such, most homeowners question neither the content of the message, nor its source.
Social control of would-be defaulters is not limited to moral suasion, however. Predominate messages regarding foreclosure also frequently employ fear to persuade homeowners that strategic default is a bad choice:
What is real -- and what is very much downplayed by these outfits [like YouWalkAway.com] -- is how completely a foreclosure wrecks your finances. Near term, you might get slammed with a massive tax bill, since forgiven debt can be subject to income tax. Long term, car loans and -- you guessed it -- home loans will be much harder to come by. How's that for walking away? This is the American Dream ended in disaster.
Indeed, almost every media story on those who "walk away from their mortgages" condemns the behavior as immoral and enlists some "expert" to explain that "walking away" is, despite any claims to the contrary, not only immoral but also a devastating event to the homeowner:
A single missed mortgage payment, says MSN Money columnist and credit expert Liz Pulliam Weston, knocks 100 points off your credit score. Every missed payment thereafter compounds the damage. A notice of default typically comes after the third missed payment, delivering a knockout blow to the homeowner's credit. ... The direct effect of any of these outcomes on credit scores is dramatic, and it ripples through every corner of borrowers' financial lives. The former homeowners will be unable to get new credit at reasonable rates, and issuers of their existing credit cards can raise interest rates because they are considered greater risks.
Similar warnings of disaster pervade the information given to homeowners by HUD-approved housing counseling agencies, such as the following from the Anaheim Housing Counseling Agency:
Losing your home can be the worst and most devastating event to you personally, and your credit history. This is a scenario that you don’t want to occur if you can avoid it! Not only will you lose the comfort of your home and your investment, but a Foreclosure will stay pending on your credit history for as long as 10 years. This will jeopardize your ability to qualify for any future home loan purchases, it may affect your ability to access loans for car purchase and other needed purchases, and loan costs are likely to be higher both in fees and interest paid.
As discussed above, fear alone is a powerful motivator. But guilt and fear in combination are even more potent. ... As such, people rarely question apocalyptic descriptions of foreclosure’s consequences.
As explored above, however, there is in fact a huge financial upside to strategic default for seriously underwater homeowners -- an upside that is routinely ignored by the media, credit counseling agencies, and other political and economic institutions in "informing" homeowners about the consequences of default. Moreover, the costs of default are not nearly as extreme as these same institutions typically misrepresent them to be. In reality: homeowners face no risk of a deficiency judgment in many states or for FHA loans regardless of the state; lenders are unlikely to pursue a deficiency judgment even in recourse states because it is economically inefficient to do so; there is no tax liability on "forgiven portions" of home mortgages under current federal tax law in effect until 2012; defaulting on one’s mortgage does not mean that one's other credit lines will be revoked; and most people can expect to recover from the negative impact of foreclosure on their credit score within a few years.
Most lenders will, in other words, take full advantage of the asymmetry of norms between lender and homeowner and will use the threat of damaging the borrower’s credit score to bring the homeowner into compliance. Additionally, many lenders will only bargain when the threat of damaging the homeowner’s credit has lost its force and it becomes clear to the lender that foreclosure is imminent absent some accommodation. On a fundamental level, the asymmetry of moral norms for borrowers and market norms for lenders gives lenders an unfair advantage in negotiations related to the enforcement of contractual rights and obligations, including the borrower’s right to exercise the put option. This imbalance is exaggerated by the credit reporting system, which gives lenders the power to threaten borrowers’ human worth and social status by damaging their credit scores -- scores that serve as much as grades for moral character as they do for creditworthiness. The result is a predictable imbalance in which individual homeowners have born a huge and disproportionate burden of the housing collapse.