By Caleb Zobrist, Esq. & Ethan Featherstone, Esq.
On January 25th of this year, the Nevada Association of REALTORS® (“NVAR”) published a state-wide study conducted in August of 2010 of households that were in some process of foreclosure or resided in high foreclosure neighborhoods and their feelings about foreclosure. The study found that “nearly one-quarter (23%) of those surveyed admitted that they “strategically defaulted” or “walked away” from their home.
Other nationwide studies have resulted in similar findings. A 2010 study by the Federal Reserve Board obtained a similar finding that showed that “when equity falls below 50 percent, half of the defaults are driven purely by negative equity.” 2009 study by Experian and Oliver Wyman, updated in 2010, showed that strategic defaults were in the 18-19% range.
Strategic default by a homeowner is generally defined occurring when a person chooses to stop paying their mortgage even though they have the financial ability to pay. The Experian study created criteria to define a person who defaults strategically as someone who stops payment on their mortgage completely while staying mostly current on other non-real estate debt.
Media references to strategic defaults are not generally positive. As Las Vegas Review Journal reporting on the Federal Reserve Board study mentioned above stated that “Strategic mortgage defaults have grown into a troubling trend in Las Vegas,” (italics added). A Wall Street Journal Article quoted George Brenkert, a professor of business ethics at Georgetown University, as saying that those who can afford their payments and were not deceived about their loan have a “moral responsibility” to keep paying. Former Treasury Secretary Henry M. Paulson Jr. declared that “any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator — and one who is not honoring his obligation.”
Does the fact that others in the market are breaking promises to their mortgage companies make you think that they are dishonest? Are you angry because their leaving their homes is causing your home value to drop? Do you feel that they are cheating the system because everyone is doing it, and that the mortgage companies are not likely to sue the persons who are walking away right now?
If you answered yes to these questions, please consider the following. Would a business that has an asset that is worth far less than what is owed keep such an asset? It depends, but if the consequences of breaking the contract, such as by paying damages to the other party, defending or losing a lawsuit become less costly than the cost of keeping the bargain, the business probably should break its bargain. This is commonly referred to in the world of contracts as “efficient breach”—breaking a contract because it makes economic sense.
Efficient breach is not an illegal action; it creates a more efficient economy as it promotes competition, maintains an open market, encourages negotiations at market price, and provides a way out of long-term and overly cumbersome contracts. Is the business that does this subject to moral criticism? That business will already be subject to a loss in relationship with the other party and perhaps receive less favorable treatment by other possible creditors or partners in future deals. Do you think that mortgage lenders are governed by morals in their decisions to consider whether to help people modify their loans, refinance, or sue them after they walk away? No way.
Why should a business get better treatment than people? Why shouldn’t a person be able to make long term investment decisions like a business? Should not a person be given more forgiveness for an efficient breach? They will have to move their family and belongings which is one of the most stressful events in a person’s life. They will suffer a severe drop in their credit rating and may not be able to buy another home on credit for years. A survey of debtors by Deborah Thorne, an Ohio University sociologist, showed that of those people who experienced a foreclosure, only 3.4% of those people were in a home with a mortgage within 3 years. They may also subject themselves to a lawsuit by the mortgage holder for the remaining balance, or deficiency (depends on your state).
If you think that the young and irresponsible are the typical culprits of strategic defaults, take a look at the NVAR study. The age group of 65 and older represented the largest group of those who strategically default at over 30% and the second largest group was those in the ages of 45-54. Searby stated that “[W]e assumed that older home-owners would have a much stronger stigma, culturally, against walking away from their mortgage when in fact it was the opposite”.
Perhaps many of the individuals are not breaking their mortgage contracts for purely investment purposes. You never know why a person is defaulting strategically. Perhaps they needed to move because they knew their job position would soon be cut or the pay would drop soon and they are planning ahead. Perhaps they need to be with an ill family member in another state for a long term period. Maybe they have decided that Las Vegas is not for them and it is time to move on. Maybe they had been trying for months to work with their bank on a short sale and it failed anyway. The reasons for their default have not received as much or any attention in the studies that have sought to define and compartmentalize those who do it, but it would be wise to hesitate before passing judgement.
While important decisions about your personal and financial life is not the same as running a business, Brett Arends said it best in a Wall Street Journal article: “Limited liability, after all, is one of the main reasons every business from your local dry-cleaner to a major multinational gets incorporated in the first place. They’re not shy about protecting themselves if things go wrong. You shouldn’t be either.”
While strategic default may be an option for you, it is best to consult with a competent attorney, such as Zobrist & Featherstone at www.zobristfeatherstone.com, to discuss all of your options before moving forward on a course of action regarding your mortgage.