A reader writes:
I'd like to hear your thoughts on what (if any) ethical obligations are due to a mortage contract in the current environment. I bought a home, and it's now severely underwater; worth maybe 50 – 60% of the purchase price. The payments are affordable to me for now, but much better homes can be had for much less now. Banks are not very accommodating to restructuring loans; many people in this situation are choosing to walk away. It makes a lot of financial sense to do so.
While at least I'm on a fixed-rate mortgage, it still features several of the creative financing schemes so popular at the time. Payments for now are 100% interest — not a penny is going to pay off the house itself (not that I would want to sink any more money into it than I have to). Then there's a big balloon payment due in a few years, and monthly payments go up at that time as well. So this mortgage is a ticking time bomb. The balloon payment is a few years off, but it's doubtful that the value will recover sufficiently by then, barring rampant inflation.
I can't give advice about what to do in the reader's specific situation (and I've edited out some additional details for purposes of protecting the reader's identity), but I can offer thoughts on the principles involved.
The Church recognizes the institution of private property and the legitimacy of sales and contracts. All of these require respect for the institutions in question that require respect for agreements made, the keeping of one's word, and respect for the property of another.
Society couldn't function if people took each others' property willy-nilly, never honored their word, etc.
So there is a basic obligation to honor one's agreements in business matters.
But just as private property is not an absolute (a starving man may steal food to feed his family provided he is not stealing it from someone who also can't afford to lose it), so contracts are not an absolute).
The truth is that in a mortgage, both parties are taking risks, but at the time they judge the risks acceptable.
Circumstances may change, however, such that terminating or breaking the contract becomes rational.
This is something to be discouraged–because society needs contract-keeping to be the norm in order to function–so there are penalties spelled out in contracts and in civil law more broadly to discourage people from doing it.
This is analogous to the penalties that are inflicted for stealing. Society needs those to discourage widespread stealing. Yet sometimes it is morally permissible to take and use another's property without his permission.
Theft is the taking of another's property against the reasonable will of the owner (meaning, it's no longer the sin of theft when it is not reasonable for the owner to prevent you from using his property).
I would suggest that a parallel principle applies here: One is obliged to fulfill one's mortgage obligations provided it is within the reasonable will of the lender.
But if one's family or personal finances will be gravely harmed by failure to walk away, if the consequences that you will suffer due to walking away are less than those of failing to do so, and if you will not be inflicting similar grave harm on others by walking away, then it is legitimate to do so.
The final condition I mentioned–not inflicting proportionate harm to others–is somewhat tricky to evaluate, but in general, pain is more bearable the more it is spread around. Generally an institution like a mortgage lender can bear the pain of a mortgage going bad than can an individual family–even though it means the pain of that loss is going to be passed on to those who own or invest in the lender or (given the involvement of the government) to taxpayers more broadly.
What happens when there are massive numbers of such mortgages going bad means there is a lot of pain being heaped on the system, but in general terms it is more likely to be handled well if distributed broadly rather than concentrated narrowly.
That's just a general principle of pain management.
So, short answer: One in general should keep one's mortgage obligations, but there are circumstances in which it is both rational and moral to walk away. This should not be done lightly (and one should not underestimate the negative consequences of doing so), but one is not obliged to drive one's finances into the ground or otherwise do grave harm to them by continuing to try to do so.
One thing that kind of disturbs me a bit, is that it sounds like the reader is going to walk away from something he deems has little value in an attempt to get something better. The payments are affordable to me for now, but much better homes can be had for much less now.. In my opinion this would not be moral. He/she should go through the process of trying to sell the property even if it means taking a loss, if he/she wants to purchase a better home.
Also when the reader purchased the home, it had a certain value, he/she knew ahead of time about the balloon payments, and in fact when a home is bought nearly 100% of the payments go towards interest for the first few years. Just because the market price of the house dropped, is not a reason to break a contract. Now if the reader had lost his job, or was diagnosed with an illness or came up on some other financial hardship, I might believe that it may be ok to break the mortgage contract. However nothing the reader stated leads me to believe that it is anything more than an attempt to take advantage of the current economic situation to his/her own benefit. Which I believe would be immoral.
A mortgage is a collateralized loan, meaning the house is pledged as security in the event of a default. You pay the monthly payments, eventually you get to keep/own the house. You default and the bank gets it back. The principle is as clear as day.
Sure there are other consequences for defaulting (such as a credit hit) but walking away from a mortgage should barely touch on morality because defaulting (with the attendant consequences) is written as part of the contract itself!
I’d typed out a long reply when the comments were out (darn it) on this, which I don’t have the time to now repeat, so I’ll make a very much shortened version of it.
I don’t think there’s a clear moral issue here for the reasons mentioned above. A mortgage is a security agreement for a promissory note, so the mere existence of a mortgage presumes a failure to pay. It’s like the bank’s ejector seat, in effect, for a failed loan, but failure is built into the scenario from the onset. If there’s a failure to pay on the promissory note, the bank may take, and sell, the house.
However, there is a legal issue here, and the debtor needs to be clear about that. Merely because a house is sold on a foreclosed mortgage does not mean that the debtor is free of his obligations under the note. He remains responsible for any deficiencies. That is, if the bank doesn’t recover all that it is owed, after selling the foreclosed house, it can hold him responsible for the difference.
I’ve foreclosed on a few pieces of property from time to time while working as a lawyer, and in my experience, this tends to come as a rude shock to the debtor. Often, they have no idea that the bank can hold them responsible for the difference after the sale.
There is a way to sometimes work this out through a process called a “deed in lieu of foreclosure”, but to do that, you really have to work it out with the bank beforehand. Otherwise, if the bank doesn’t get all its owed, they’ll look to the debtor. If the bank gets more than its owed, which is rarely the case, the surplus goes to the debtor or other lien-holders. Best to know what you’re really looking at here.
What I also meant to add is that the debtor here needs to speak to his lawyer before walking away from his house. Otherwise, the debt may follow him around in ways he didn’t anticipate.
Yeoman,
The point you bring up differs state by state. The state I live in, Arizona, the debtor is protected by law from this debt following him around after foreclosure.
I wrote the original email that is the subject of this post. In response to Greg’s points:
My statement about more desirable homes being available for much less is just a statement of market reality, and the pretext under which many people are abandoning their homes. That’s not to say that I’m going to walk away simply to get a nicer home. Actually if anything, the size of the payments, and the fact that they’re 100% interest, is more of an issue. It’s akin to renting, only worse.
Selling at a loss would be untenable if I were saddled with that debt. It would probably be a $60,000 – $80,000 liability at current market prices. Fortunately, though, I think typically the owner is not given responsibility for the loss on a short sale.
Regarding the value of the home — I think it’s almost impossible for the average person to make a good judgment of the value of something like a home; furthermore we were led to believe that housing prices would appreciate quite a bit over time. The only relevant metric for most people (myself included) is the size of the mortgage payments. Does anyone really live in their home for 30 years and pay off the entire mortgage?