Raw Finance

As the housing market struggles to get back on its feet and reduce the large inventory overhang from 2007, it will face yet another test as many homeowners are now so far underwater in their homes that it will no longer make sense for many to keep paying the mortgage.  More than 10 million households in the U.S. have underwater mortgages—that is, homes that are worth less in value that the mortgage payer owes. These homeowners often cannot take advantage of lower rates on loans or refinancing deals.  With home prices still bottoming and likely to take many years to recover, it makes financial sense for many to simply walk away from the mortgage.

National Public Radio’s Planet Money blog recently posted a letter from an underwater homeowner in Stockton, California, that captures the calculations and the psychology of walking away.  The letter is reproduced below and embedded with links to related NPR stories.  All of this is a stark reminder that there is a long road ahead for the recovery in housing and prices may bounce along the bottom for an extended period of time.

However, most homeowners should not feel discouraged as the problem of underwater mortgages is concentrated in the same states that have had the biggest drops in home prices due to the financial crisis—Florida, Nevada, Arizona, California, and Michigan.  Also, anyone considering walking away from a mortgage should consider factors beyond just the immediate home—one significant result is the damage to one’s credit rating.  Defaulting on a mortgage could result in the homeowner being unable to get a credit card or a car loan later on, or paying more for such consumer loans.  It also means that one probably would not be able to get another home mortgage for at least three years, or maybe five years.

Here is the letter:

We have a home in Stockton not too different from the hypothetical in your episode. 400k 1st and 2nd mortgage, 250k house value. We have an interest only loan, costs us $2k/month and we’re building no equity.

The two reasons we haven’t stop making payments is we’re waiting to see if the government does anything (the HAMP program is not useful to us since the mortgage is more than 125% of the value of the home), and we need to figure out the right time to take the hit to our credit score.

I’m not sure why it’s hard to understand why it makes sense to walk away. If house prices climb by 5% a year, it’d be 15 years before we broke even and house prices here aren’t going to do even that. All the while paying $24k to the bank in interest per year. This is what’s so crazy about the government’s HAMP program, without writing down any of the principal, there’s no reason for us to stay.

If the loan were written down to 275-300k, we’d probably figure out how to stay. Our credit is worth 25-50k, but it’s not worth 150k, and so we would eventually walk. I don’t begrudge any of neighbors who may have done the same. We can rent for half the price. Over the 15 years to break even, it would cost us $12,000 a year in extra payments for no equity and we’d be trapped in the home.

Also, having been involved in commercial real estate ventures, i know the bank wouldn’t hesitate to walk away if it were in my shoes. They are guided completely by what is in the contract, nothing more or less.