Month: June 2010

IS NOT PAYING YOUR MORTGAGE WRONG?

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Many people are talking about strategic defaults. If you don’t know what a strategic default is, it’s when a homeowner can afford the mortgage but the home’s value is so far below the amount owed on the loan that the homeowner decides to walk away rather than pay. The legal and tax implications of a strategic default are left for another discussion. What follows here is a consideration of whether strategic default is “wrong.”

I have heard people heatedly argue that when a person takes out a mortgage, he or she has made a solemn oath to pay back the money, and should pay that money come hell or high water. Aside from being an exaggeration, such a statement is only partly true. Cutting right to the heart of what a mortgage really means, the mortgage is simply an agreement between homeowner and bank that either of two things will occur. This is a very important concept to understand. The mortgage does not only state that a borrower must pay the money back. The mortgage states: (1) If the borrower pays the money back, then the lender will release its lien on the home or (2) If the borrower does not pay the money back, then the lender can take the home.

Reread one and two above and while doing so, keep the two parts completely separated by the word “or.” Lenders are professional mortgage players with full understanding of all the risks of loaning money secured by real property. Lenders use expensive Ivy League lawyers to draft their paperwork. Lenders employ experts in theoretical mathematics to create payback schedules. Lenders have Wall Street’s sharpest wits mix bad loans with good and create sausage-meat investment funds. Lenders reap huge profits at every step in the lending process from funding loans to selling toxic loan pools to unsuspecting investors or passing them to government (tax-payer) backed securitizers. The average homeowner couldn’t trick a lender if his or her life depended on it. Borrowers are basically given take it or leave it choices when it comes to getting mortgages. It is, and has always been, slick and savvy lender versus little ignorant borrower all the way through the process.

With that understanding, and the understanding that the lender fully understands every finely printed term on every page in the loan documents, it is obvious that the lender fully contemplated what it wants to happen when the borrower does not pay. In fact, most of documents in the huge packet of loan documents address what happens when the borrower does not pay as opposed to what happens when he or she pays.

It would be wrong if a lender accepted all the payments required and then kept the lien on property. It would be wrong if a borrower does not pay the mortgage but gets the lien off the property. What is not wrong is when one of the two outcomes contemplated in the loan documents occurs exactly as contemplated. Neither lender nor borrower breaks a promise when either one of the two contemplated outcomes occurs.

Putting it even more simply, lenders are big boys and know exactly what they are doing. Lenders know the risks of borrowers failing to pay. Lenders know the ups and downs of real estate markets. Lenders know how to pass any losses they suffer onto borrowers and the U.S. government. It is wrong to take advantage of the uninformed. Exercising one of two fully-contemplated options is not wrong.