So When Should You Default on Your Mortgage?

I think the people that I am arguing with about "strategic mortgage default" are probably closer to my position than they think they are.  Just to clarify a few things:

1.  I do not want any change in the laws surrounding default; I think mortgage default is a necessary safety valve for the financially troubled.

2.  The people I am talking about are people who can afford their mortgages, but would rather have taken out an exotic option to buy the house if it happened to go up in price, than the mortgage contract and promissory note that they actually signed.

"Can I afford this mortgage?" is, of course, a subjective question, one that only you can answer.  But I think it's probably worth outlining the questions I would ask myself before I defaulted on my mortgage:

1.  Have I made a good faith effort to cut my expenses?  Have I cut out cable, sold pricey vehicles or boats, really taken a hacksaw to the grocery bill, stopped eating out when avoidable, and given up vacations except for the cheap'n'cheerful visiting family kind?

2.  Have I made a good faith effort to ramp up my income?  Have I looked for freelance work, part time jobs?  Have I considered taking a roommate if my family circumstances make that reasonable?

3.  Is the mortgage cutting into necessary savings?  After I have worked on the income and expense side, can I pay the mortgage while still saving

a.  15% of my income for retirement

b.  An adequate sum for college if I have kids

c.  An emergency fund of at least 6 months worth of expenses

d.  Any savings for special needs (say, "We think Fred will need a wheelchair ramp in five years).

4.  Would keeping the house endanger my family's health or education?  If your two-story house is too far underwater to sell, you don't have spare cash to feed the mortgage a bit while you rent it out and wait for the market to recover, and your husband just came home from the hospital in a wheelchair, for Christ's sake, default on the house if you don't have enough savings to make up the equity shortfall.  Ditto if your kid is getting repeatedly mugged at school/failing to learn algebra.

5.  How likely is this circumstance to change?  If you just lost a job that was necessary to pay the mortgage, I wouldn't make it my first priority to default.  But if it's been nine months and the mortgage is chewing through your savings, it's time.  If the income shock looks likely to be permanent--a disability in the family, say--then there's no sense prolonging the inevitable.  Stop paying and start talking to the lender about a short sale.

On the flip side, if you think you'll make more money later, it seems both honorable and sensible to me to take an extra job for a year or two to plug the gap until your income goes up.  It does not make sense to me to pledge to work 70 hours a week for the next 20 years, and never see your family, in order to feed the house.

6.  Is the bank going to come after me for the deficit?  This varies by state. If the deficit is smaller than your emergency fund, I would tend to say that except in extraordinary circumstances (say, someone just lost their job), you should use the emergency fund to sell the house and make up the deficit.  This is as much of a practical as a moral consideration--you will be better off saving up $25,000 again than you will trashing your credit and/or getting yourself sued.

If the deficit greatly exceeds your assets outside of retirement accounts (which creditors can't touch), then there's no point; go ahead, do a short sale, a deed-in-lieu, or let them foreclose; and if they really come after you for the deficit and won't negotiate down to something you can pay, talk to a bankruptcy attorney.

As you can see, I think that people who are in financial trouble and cannot make their mortgage payment have a perfect right to walk away--and to do so as early as possible if there is no reasonable likelihood that their circumstances will change.  On the other hand, I think that if modest lifestyle changes like less steak and more hamburger, less cable and more library books, can make your mortgage payment affordable, I think you have an obligation to make those changes.  And if those changes aren't even necessary--if the default is purely and simply because you would like the bank to eat the lost equity rather than you--I don't think that's right.

But for all the discussion of those people, I'm not sure how many of them there are.  Some, undoubtedly--in a country as big as the US, there is always some jerk doing almost anything you can imagine.  But given what we know about bankruptcy, I tend to think that the overwhelming majority of people walking away from their houses are doing so because they cannot support both the home, and a basic decent life for their families.  Obviously, I also tend to think that's how it should be.

Obviously, I'm much more sympathetic with low-income defaulters, who have little room to cut, than with a family that makes $250,000 a year.  There's a lot that can be cut out of a high-earner's budgets; almost nothing that can be cut if a family is living on $35,000 a year.  Find your way to Goodwill a few times before you come to me and tell me that you can't possibly cut the clothing and furniture budget another inch.

It's quite possible that more people should be defaulting on their mortgages.  But I don't think that we should encourage them to on the grounds that "Hey, corporations do it!"  Rather, I think that the proper way to look at it is that while your promises to the bank are very important, your promises to your family that you will keep them decently clothed, sheltered, fed, educated, and prepared for a time when they cannot work . . . those promises are even more important, and you have an obligation to honor them before your promise to the bank.