A recent study evaluated homeowners’ attitudes towards walking away from underwater homes. According to the study, hardly any homeowners would consider walking away when a mortgage is only 10% more than the value of the property. If the value of the home continued to drop below 50% of the mortgage amount, only 17% of homeowners would abandon the loan.

Overall, 80% of those involved in the study considered defaulting as a financial strategy to be an immoral practice.

Additionally, homeowners who owned their homes for more than five years were almost 80% less likely to consider a default as a financial strategy compared with those who had recently purchased their home. Relationships with neighbors and with local schools are cited as the main reasons.

In addition to presenting the study, the New York Times reports the consequences of walking away from an underwater home:

  • the homeowner’s credit score would drop by at least 100 points, and the foreclosure would be on record for seven years;
  • lenders may be reluctant to approve a loan for a new home, even if a homeowner’s good credit returns relatively quickly;
  • a homeowner would be unlikely to get a personal loan or car loan;
  • credit received by the borrower would come with higher interest rates and lower limits; and
  • come employers check credit reports, which might lead to trouble finding a job.

first tuesday take: Homeowners are focused on short-term morality. They are concerned with “What will the neighbors think?” and the trouble of abandoning a home and leaving a vacancy in the neighborhood.

Everyone needs to take a deep breath and consider two very important factors.

One factor is the reality of the financial crisis, which went to the core of lending, sucking the financial life out of real estate. This went beyond a simple Federal Reserve-orchestrated business recession.

The second factor to consider is that lenders will lend. It is the very nature of their business. It is contrary to their best interests to lock out the millions of future borrowers (including well over a million future borrowers in California) who have defaulted or lost their home.

Lenders will rationalize any “dings” on credit as results of the financial crisis suffered by the lenders rather than the full fault of the borrower. Do not underestimate the ability of lenders to forget the past, or disregard lending fundamentals in order to turn a dollar.

Congress allowed lenders to run animal-wild for nearly 30 years, resulting in the current mess facing the real estate market. Congress and the California legislature are still lapping at the feet of the lenders, asking nicely for loan modifications that lock homeowners into ballooning principal balances secured by upside down properties, when they should be mandating reduced principal balances to meet present values, which will keep the (hopefully) employed homeowners in their properties.

Lenders currently want to push their responsibility for wildly excessive lending down onto homeowners. It is in a lender’s very best interest to paint a picture of moral travesty for owners thinking about walking away.

Walking away is not ideal, as the New York Times points out, but it is much better that extend and pretend modifications that stick homeowners with a dead-end loan.  And in California, a nonrecourse state, the purchase-assist homeloan has absolutely no liability tied to it for a deficiency in the property’s value to support a full recovery by the lender.

For more information regarding California as a nonrecourse state, see the [November 2009] first tuesday article, California homeowners: exercising your right to default.

Re: “Homeowners Walking Away,” from The New York Times