White said it is about fear and anticipatory shame. "They think about how they would feel if they walked away from their mortgage," White said.
And they think it is immoral.
White said about 70 percent of Americans think defaulting on one's mortgage is always immoral.
Smith is in the position of someone who is underwater in his home and stays. He said from his point of view he wouldn't feel comfortable walking away. "I didn't walk away because I can pay it. It was my choice," Smith said. "When people get a loan and in good faith sign it, they have a financial responsibility to pay it. They thought it was reasonable when they made the purchase, the only thing that has changed is the value."
Luigi Zingales, a professor at the University of Chicago Booth School of Business, has written on "The Menace of Strategic Default" and is glad people perceive a moral cost to walking away from their homes. He said there is also a stigma associated with it — and that stigma is reflected in a long-term ding on your credit rating. "And many people are hoping this whole thing will recover," Zingales said.
But White thinks financial reality pushes in a different direction. "The media, government and financial institutions convey the message to homeowners that it's basically financial suicide to default on their mortgage," White said. "The reality is, for many people, walking away from their mortgage is the first step to regaining their financial footing. It could be the best financial decision they'll ever make."
Why walk away?
For the majority of Americans, a home is their primary form of investment for retirement and to send their children to college. But when a homeowner is underwater, White calls it a "toxic investment" with real detrimental costs against future financial success.
Banks have little financial incentive to negotiate a change in a mortgage with someone who has good credit and pays on time. "If someone calls their lender and says, 'I'm in a bind. I'm deeply underwater and I need to work something out.' And then the bank doesn't return their call or refuses to deal with them, then I think the borrower can take their cue from the bank and say, 'Hey, I'm going to behave in the same kind of ruthless economic manner and do what's in my economic best interest.'"
And that means strategically defaulting on the loan.
White said the mortgage contract — that the bank drafted — sets out the consequences for default. "There is nothing morally wrong to holding the bank to its agreement," White said, "and exercising the right to default as long as you are willing to accept the consequences — which are the bank has a right to take your home, and in some states they have the option to pursue a deficiency judgment for the difference."
The danger of a deficiency judgment is a risk. But White says banks usually don't pursue deficiency judgments for financial reasons.
Moral damage and loss
Zingales said he has no problem with a "non-recourse mortgage" that states clearly that the borrower can stop paying and give back the house. "That is perfectly fine. That is what commercial lenders do — and they pay a higher interest rate because it is a non-recourse mortgage."
But for residential mortgages, this is rarely the case. In Illinois, for example, the lender can take legal action for the deficiency, but suing can itself be costly for lenders and so they avoid it. But Zingales doesn't think its rarity should be an encouragment to choose default. "It is like saying it is fine to not pay taxes because it is very difficult for the IRS to get you."
He worries that if people default more it will lead to lower real estate prices and create "moral damage" that will make it easier for society to ignore their promises.
"I feel pretty strongly about the social norm that when you make a promise you shouldn't try to breach it unless you are desperate," Zingales said. "From an economic point of view we should have that norm and we should try to enforce it because it makes society work better."
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