Roger Lowenstein is a sophisticated financial journalist and managing director of the Sequoia Fund, so some readers might be inclined to take his New York Times Magazine column “Walk away from your mortgage!” seriously. According to Todd Zywicki, by recent count, some five million homeowners are currently delinquent on their mortgages and some 12 million to 15 million homeowners owe more on their mortgages than the home is worth. For them Lowenstein has arrived with the simple message he exclaims in the title of his column.
It is easy to mock bankers who encourage consumers to honor their obligations and to calculate the advantages of walking away from a mortgage that is underwater. This Lowenstein does. Lowenstein ridicules the esteem in which the virtue of paying one’s debts is held. He aims his column squarely at those who have a choice whether to continue to pay or bail out. He advocates bailing out on purely economic grounds.
The last words of Socrates as reported by Plato in the Phaedo are: “Crito, I owe a cock to Asclepius; will you remember to pay the debt?” Having had Socrates rather than Lowenstein for his teacher, Crito came through big time. “The debt shall be paid,” Crito assured Socrates as Socrates expired. Thankfully, Lowenstein’s teaching has not yet achieved classic status, although it’s getting there.
Lowenstein seeks to disabuse his readers of their virtue as passé. Lowenstein emphasizes the advantages of default when the borrower’s home is underwater. But what about the costs? Lowenstein gets around to them briefly toward the end of his column:
Mortgage holders do sign a promissory note, which is a promise to pay. But the contract explicitly details the penalty for nonpayment — surrender of the property. The borrower isn’t escaping the consequences; he is suffering them.
In some states, lenders also have recourse to the borrowers’ unmortgaged assets, like their car and savings accounts. A study by the Federal Reserve Bank of Richmond found that defaults are lower in such states, apparently because lenders threaten the borrowers with judgments against their assets. But actual lawsuits are rare.
And given that nearly a quarter of mortgages are underwater, and that 10 percent of mortgages are delinquent, [Professor Brent] White, of the University of Arizona, is surprised that more people haven’t walked. He thinks the desire to avoid shame is a factor, as are overblown fears of harm to credit ratings.
I may be wrong, but I think this is misleading at best. A discussion of the legal issues related to default is complicated by the wide divergence in the applicable law among the states. For every general statement there are exceptions and qualifications. Nevertheless, I believe that the following unacknowledged considerations are relevant to Lowenstein’s advice:
1. As Lowenstein states, when a borrower takes out a mortgage loan he generally gives the lender a security interest in the property (the mortgage) and a personal pledge to repay the loan (the promissory note). I think it’s fair to say that the law of most states distinguishes between purchase-money and other residential mortgages with respect to default and foreclosure. State laws frequently distinguish between purchase-money mortgages and other residential mortgages, including refinancings, second mortgages and home equity lines of credit.
2. One cannot intelligently assess the implications of walking away from mortgage obligations without taking account of the difference between purchase-money and other mortgages under state mortgage deficiency laws. This Lowenstein does not do.
3. As a general proposition, with great variation in the details, the law of most states allows lenders to obtain a deficiency judgment enforceable against the assets of a borrower who defaults on his mortgage. Take a look, for example, at this 50-state survey.
4. The law of some states limits the right of lenders on purchase-money mortgages to recover through foreclosure under so-called anti-deficiency statutes.
5. The law of these states generally does not limit the right of lenders to recover against the assets of borrowers on non-purchase-money mortgages.
6. Table 1 of the Federal Reserve of Richmond study cited by Lowenstein classifies 11 states as “non-recourse.” The other 39 states provide for recourse against the borrowers’ assets. Even with respect to supposed non-recourse states, complications may apply. In Minnesota, which is listed as a non-recourse state in the Fed study cited by Lowenstein, only foreclosure by advertisement precludes a deficiency judgment; foreclosure by action does not.
7. Even in non-recourse states, borrowers with non-purchase money mortgages may be subject to deficiency judgments.
8. Lowenstein asserts that actual lawsuits are rare in states that allow for deficiency judgments. If the borrower subsequently purchases a property in which to live or otherwise has income or assets with which to make good on his mortgage obligations, the prospect of a deficiency judgment should be taken into account.
9. Borrowers who follow Lowenstein’s advice and escape from mortgage obligations by walking away from their mortgages may be required to treat forgiveness of the unpaid mortgage debt as income for tax purposes, although this provision of federal tax law has been temporarily suspended through 2012 by the Mortgage Forgiveness Debt Relief Act of 2007.
10. Lowenstein advises borrowers whose loans are underwater to default. Lowenstein blows off the impact of default on credit ratings, characterizing them as “overblown fears[.]” Here we have only Lowenstein’s ipse dixit. However, these fears may well be appropriate, and they may bite if the borrowers’ credit scores are affected prior to the time they seek to buy or rent another property in which to live.
All things being equal, I would prefer to repay my debts. Solely on economic grounds, however, I believe that one would be ill advised to take Roger Lowenstein’s advice seriously without substantially greater analysis than Lowenstein offers.