Investing Hiring

Is It Ethical to Walk Away on a Mortgage?

I may have just ruined a friendship from my college years by being honest.

A few days ago, I received a long email from a friend I keep in occasional email contact with. That friend, who I’ll call Lindsay, is in an upside down mortgage – the current estimated value of the house is about 10% less than the amount still owed in the mortgage, and that difference is enough for a large down payment on a similar house in Iowa.

Anyway, Lindsay asked me how the housing market was in Iowa, since she was planning on moving back to the area with her family. I gave her my thoughts (pretty stable with some small growth in the “big” areas near Des Moines and Iowa City) and expressed some surprise that she was considering moving back.

In response, she flat-out told me that she was going to walk away from her mortgage. Instead of getting a mortgage for a house here in Iowa, she was going to pay for it all in cash (by cashing in some stock options), then walking away and handing the bank the keys to the house.

I wrote her back, told her my opinion on the move, and haven’t heard from her since.

In a nutshell, I feel that walking away from a mortgage is horribly unethical. While there might be a solid financial argument for doing so right now, it’s a complete act of bad faith, one that, as a borrower, you would never dream of accepting from a lender.

Let’s just translate it quickly into different terms. Let’s say you want an XBox 360 game console and a few games, but you don’t have the cash to pay for it. You agree to borrow $600 from your friend and you’ll pay that friend back $30 a month for 24 months to cover the cost. Three months in, you’ve defeated Halo 3, Orange Box, and Bioshock and have decided you’re tired of the console, so you announce to your friend, “I’m tired of paying you. Here’s the console and the games. They’re used. Oh well.” and walk away.

Or, you can reverse the equation. Let’s say you’re in an area where the home values are skyrocketing. You have a fairly new mortgage, but have built equity in your home. The bank decides, “Hey, we can cash in,” and then boots you from your home, regardless of whether you’ve paid the bill on time or not.

In short, any time you agree to borrow or lend from someone else, part of the assumption is good faith. Both partners believe that the other will operate in good faith to go forward with the borrowing agreement. From my perspective, walking away is not good faith.

Not only that, it’s also financially stupid when you start looking at the big picture. It drops an atom bomb on your credit for at least seven years, during which you’re going to be forking out a lot more for every type of insurance and also have horrible rates on things like car loans and so on – and don’t even think of trying to get another mortgage for a long time.

Another thing to consider: at some point, the market will rebound, and it’s already down 20% or so (depending on where you’re at). Whatever happened to “buy low, sell high”? Right now, you’re selling low – or at the very least, selling nowhere near the high. That’s just not solid investing – that’s the equivalent of buying a stock, watching it plunge 20%, then selling it immediately because it’s “bad” even though the same solid fundamentals exist.

A third factor: you’re probably walking away because you’re in an adjustable rate mortgage that’s either recently adjusted or about to adjust. The government is about to bail you out. Take a look at the Dodd-Shelby HOPE for Homeowners Act, among other things. Uncle Sam is going to step in and keep you safe from your own financial mis-steps.

An aside about the housing bailout: I really feel like the bailout is sending the wrong message to homeowners. Take me, for example. In 2007, I could have signed up for an ARM at a very, very low introductory rate, borrowing roughly twice as much as we did for a home. Instead, I looked at our finances, ran the numbers, was realistic and honest, and got a fixed rate mortgage that I knew I could afford. One year later, the government is bailing out the people who didn’t bother to do the homework and doing nothing to help the responsible people who made a well-considered choice. I understand that some families are in need, but it also sends a message that irresponsibility will be protected by the government.

In short, I’m not a fan of walking away from a mortgage. In the big scheme of things, it barely makes financial sense, and it certainly raises some big ethical flags. From my perspective, it’s not something worth doing. I’d love to hear your perspective.

Here are some additional thoughts on walking away from mortgages.
Why Not Just Walk Away from a Home? (@ npr)
New Attitude: It’s OK to Walk Away from a Mortgage (@ wall street journal)