Should Homeowners Be Able To Walk Away From Mortgage?
Senior Editor, CNBC
Should homeowners who are behind in their mortgage be allowed to just walk way from the payments? A University of Arizona law professor suggests that maybe they should.
While not recommending that homeowners forgo their responsibilities, Professor Brent White told CNBC Monday that there is a different set of rules for the business community and homeowners. (See video below for full interview).
"There's a double standard when it comes to banks and homeowners," said White. "Businesses often walk away from bad contracts, but homeowners can't. The banks need to modify bad loans."
White recently issued an academic paper saying that he's surprised that more of the 15 million US homeowners who have underwater mortgages—or mortgages that are worth more than the value of the house— are still continuing to pay.
White said he was not advocating what homeowners should do, but raising a key issue—that homeowners need to think what's best for them.
Somewhat predictably, those within the real estate industry are not endorsing White's point of view.
"It's not a responsible thing to do (not pay a mortgage)," National Association of Realtors spokesman Walter Maloney said. "He's making assumptions about property values that are not correct. Values are starting to stabilize. More important, it's not ethical to walk away from the mortgage."
But White, in his paper, is throwing ethics right out of the equation. He says, people are too worried about the feelings of shame and embarrassment of a possible foreclosure and "ignore the powerful financial reasons for doing so."
White attacks the banks in his thesis for "being slow to modify troubled mortgages and reluctant to reduce principal debts" with falling housing prices. He says homeowners have to think about themselves and what's do right for them.
And White says the penalties for skipping mortgage payments are "not as bad as people think." He says that "if you stay current with other creditors, one can have a good credit rating within two years. Most individuals should be able to plan in advance for a few years of limited credit."
But having a bad credit rating even just for a couple of years, should not be a goal, says Diane Saatchi, vice president of Corcoran Realty, in East Hampton, New York. "I grew up knowing your most valuable asset is your credit rating," Saatchi says. "It's foolish to deliberately make credit rating worse. If you can't or won't make the payments, get in touch with lender, and work it out."
In his paper, White laid out his strategy for the non-payment program: homeowners would buy the items they'll need, like a car or even another house, over a couple of years just before they stop making mortgage payments and are eventually forced out of the home.
But that's not much of a plan says Greg McBride, senior analyst at Bankrate.com.
"Buying a home is long term investment, it's not a get rich quick scheme," says McBride. "If you can make the payments you should, unless there's a major event, like a job loss or transfer that makes things worse. If that happens, you can negotiate with the bank."
While White's ideas are mostly considered extreme within the housing industry, there is an alternative to stopping mortgage payments if you want leave a house that is "underwater', says Johnny Martinelli Broker owner of Levy Mart Real Estate in Norman, Oklahoma.
"It's called deed in lieu," says Martinelli. "Say your house is worth $140,000 and the mortgage is valued at $200,000. You could go to the bank and say here's the deed. If the bank agrees, they would take over the house. But you would have to claim the difference of the $60,000 on your tax returns. That's considered income. Of course, you have to find another place to live."
The tax rules can vary at times, due to recent changes in guidelines. (Details here)
Martinelli says this type of deal is better than a foreclosure and wouldn't hurt a homeowner's credit rating as much. Advantages to a lender include a reduction in the time and cost of a repossession, which can take months. Not all banks might accept such an offer, but there are some that do, says Martinelli.
Most analysts agree that if a homeowner can pay the loan, do so even if the value has dropped. If the owner can't afford the payments, go to the lender to try and work out a lower payment. Not all lenders will, but experts advise trying.
There's also a short sale if the house must be sold. That's where the mortgage lender agrees to discount a loan balance because of an economic or financial hardship on the part of the homeowner. The homeowner sells the property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender.
Whatever action a homeowner is contemplating, they should think long and hard before doing something that could be short sited says Diane Saatchi.
"Blaming the bank is a losing proposition and could have long term consequences," Saatchi says "Don't think by not paying your mortgage you're able to get ahead financially. It's a risky idea and not worth it."