Social Question

LostInParadise's avatar

Is it unethical to allow your house to be foreclosed?

Asked by LostInParadise (24921points) February 5th, 2010

I just heard on the news that many people whose houses are worth much less than they paid for them have stopped making payments in order to have the bank foreclose, so they can buy a new house and make smaller mortgage payments. The news announcer said that many more people might be doing this except that they view voluntary foreclosure as unethical. Is it?

Should voluntary mortgage payment default be viewed as breach of contract? Could it not be said that foreclosure in response to non-payment is built into the contract and that the home owner is just exercising an option in the contract?

Suppose we extend this idea. Is civil disobedience really disobedience? Instead of viewing a law as saying that you must or must not do something, could it not be viewed as providing an option? You can either refrain from robbing banks or allow yourself to be imprisoned. By openly carrying out certain acts and willingly accepting the consequences, doesn’t this make you compliant with the law?

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32 Answers

laureth's avatar

I suppose this would be a choice between keeping your word of honor, or breaking the promise you made to pay for the thing you said you’d pay for. Seeing just how many lives are spanked by the foreclosure crisis, though, makes me wonder how it would be considered “ethical” to not only break your promise (contract), but allow your neighbors’ property value to decrease, other people lose jobs, etc.

LostInParadise's avatar

Suppose we consder an extreme case. What if the house was worth 10% of what the owner paid for it. Do you think that it makes sense to pay ten times as much mortgage as the house is worth?

I also don’t see how it follows that the neighbors’ property values will decrease or that other people will lose jobs. Once the bank forecloses, it has every reason to sell the property for whatever it is worth. The bank also has the option of negotiating with the owner for a lower mortgage payment.

Rufus_T_Firefly's avatar

Of course, the banks also have the option of customizing the rates to what the customer can actually afford. Yeah, I know that ultimately, the borrower has the final say by accepting the loan and agreeing to repay that loan, but a home can be expensive enough without the banks gouging the end-users for obscene profits.I know that some will say the customer shouldn’t have accepted the loan, but when you’re in dire need of a decent place to live, that option doesn’t always present itself. I think a lot of them okay the loan, just so the customer WILL default. Then, not only is the customer still on the hook to repay the loan, even if they become unemployed or critically ill, but the bank can then legally resell it, making even more obscene profits off of the very same house. There’s nothing equitable about it when the banks have the legal ability to ruin someone by supposedly helping them.

Zuma's avatar

I think that Stephen Colbert summed it up best.

Tropical_Willie's avatar

@LostInParadise
In the Raleigh, NC area some real estate agents figure HALF of the houses they currently selling are foreclosed or extreme short sales.
The ethics question is did the house owner enter into a contract knowing the would be unable to pay?
That is to say did they buy to sell at a higher price on a short term gain ( flip the house or pure speculation )?

EmpressPixie's avatar

I’m going to look at this from a cold point of view—the same point of view that your bank would use. People should look at their contract, figure out the long-term damage to their credit and their lives and then make a systematic appraisal of the pros and cons of leaving the house. There are penalties involved in breaking contracts. They are usually spelled out in the contract. That means that if you knowingly look at the contract and the penalties and still determine you are better off breaking it, then there is nothing wrong with doing so.

john65pennington's avatar

You are mixing civil law and criminal law in your question.

Merriment's avatar

Foreclosure isn’t a matter of simply quitting making your payments and moving on to purchase again. Foreclosure damages your credit to such an extent that moving on and being able to purchase another home very difficult.

Most of the people I know who have gone through foreclosure have been reduced to renting for the next several years at least.

It is a clause built into contracts…for the lender’s protection. Is it unethical when the lender exercises their options? That people are having to use it because they are drowning in debt doesn’t make it more or less ethical than when the lender does.

It’s not as if homeowners aren’t “punished” for using this option with wrecked credit.

The real solution would be for lenders to work with customers to rework the loans to reflect the reality of the market. This is not a typical scenario wherein house values have fluctuated in a normal market and people are trying to get a “refund” of their foolish overpayment. Instead it is a economic disaster as worthy of aid as any other disaster.

john65pennington's avatar

Merriment, you have given an excellent answer. john

Merriment's avatar

thank you, John

robmandu's avatar

Business ethics? No. As stated already, there are already clauses in the contract to ensure that the lender isn’t left empty handed. Companies break contracts all the time and usually pay some penalty. That’s just business.

Still, I too would like to see what @Merriment suggests occur more often, re: “The real solution would be for lenders to work with customers to rework the loans to reflect the reality of the market.”

I don’t think it’s best for the homeowner to just “walk away”. Assuming the person still has the job/income he had when the house was purchased, it’s silly to me that anyone would “buy high” and “sell low” (or more correctly, “give away for nothing”).

And then, from the bank’s perspective, selling houses at foreclosure usually only gets back a fraction of the balance owed.

So, I think there’s enough incentive on the table that both the borrower and lender could come together to negotiate something more beneficial. On the other hand, I can also imagine a number of edge cases whereby fraud could occur and perhaps the risk is simply too much… explaining why banks prefer the foreclosure approach.

Finally, a warning to any homeowner considering walking away from an existing mortgage with the plan of just renting for the next seven years until your credit history clears up. It’s not that easy.

A poor credit rating means you’ll pay more for rent, insurance, other loans, etc. Nor are you guaranteed that at the seven year mark, it’s all washed away clean. There are ways for the creditor to ensure that the bad item remains on your credit history, which in essence resets the seven year clock each time. This particular monkey can be a tough one to shake off your back.

Merriment's avatar

The advantage to the owner “walking away” is the money they will save from not struggling to make the payments only to ultimately “fall short” and be foreclosed on by the lender. At that point all those very hard earned struggling payments become just money down the toilet (the toilet they no longer own). It is a way to cut their losses while they can still afford to eat and hopefully afford the rent somewhere cheesy that won’t require decent credit checks.

It would be stupid to buy high and sell low but it is removed from profit and loss theories when it gets to this point and is more about basic survival.

Banks prefer foreclosure because they can make money off it. Sure you don’t have to pay them back your original mortgage but it isn’t like this is a total loss for them. They get the house and turn around and sell it to the next contestant on the “American Dream” roulette wheel. Meanwhile they have also pocketed all the payments the original buyers have made.

The real losers in this scenario are the people who have been encouraged to buy the maximum amount of home that their “good times” budget would allow in an artificial “boom” time.

Bottom line: If foreclosure weren’t more profitable for the lenders in ways we aren’t even privy to, they would be sitting down with strapped borrowers and trying to salvage the situation.

My best advice in this scenario would be to work with your lender to get extensions and to make partial payments and then do everything you can to sell the home immediately and before you are foreclosed on.

Even if the sell is totally upside down and you have to pay something to sell it. Save the partial payment money you would be throwing down the well and use it for those costs. Real estate agents will often have to wally up part of their commissions at the closing of these deals to “save” the transaction.

If you sell before they can foreclose, you will be broke but you won’t have a foreclosure hanging over your head.

robmandu's avatar

It’s the “basic survival” bit that bugs me.

Of course, in these economic times, lots of folks have lost their jobs and whatnot. In a loss of income scenario, drastic measures must be taken, of course.

But a lot of these folks still have their jobs and income. They could make the (now artificially high) original mortgage payment. But they simply choose not to and walk away based on some perception of lost value.

And the thing is, these same folks, bubble or no, knew they were buying into an investment that had been skyrocketing in price for a while. That’s always a warning sign, good economic times or no.

In the Highland Park area of Dallas, the appraisal authority had noted that for the last couple of years prior to the economy going bust, that home prices there had increased on average of 100% a year. Entry price for many homes there was a cool $1M.

So… if I’d had a million bucks, I could have conceivably doubled my investment in one year just by buying a house in HP and sitting on it. That kind of statement reeks of significant financial risk. Sure, it might’ve worked for some folks, but they should have understood the chances they were taking. If not, well, caveat emptor.

Merriment's avatar

Of course there are always going to be shysters and thieves who made poor decisions and are unwilling to pay the piper for this time when their gamble didn’t pay off.

But just as often there are first time home owners/buyer’s who have little knowledge of or experience with the real estate market, the predatory practices of lender’s or the tendency of Realtors to encourage you to purchase the most home you can so their percentage of the sales price commission will be higher.

It is these people who are solidly between a rock and a hard place. These aren’t million dollar homes these are “starter” and basic homes that only through the power of the false economy ever priced in the high $200 range.

In reality, which is where these people find themselves residing now, these same homes are worth less than 50K.

The people who can “afford” to walk away in a snit because they feel “cheated” by the unmasking of the true value of their home are people I hear talk of and yet have never met even one. I doubt they exist in any great numbers because doing this foreclosure because you lost value only to destroy your own credit rating is a true “cutting off your nose to spite your face” maneuver.

The people I know that are in this situation are people who can no longer afford their mortgage. They are facing unemployment or reduced employment just at the time when buy now pay later balloon payments or interest rate hikes are coming due.

robmandu's avatar

@Merriment, I think we’re largely in agreement.

I’m not as forgiving of these ignorant first-time home owners, though. I, too, was a first-time home owner. And indeed, there are things I’ve done differently since. But the responsibility has always been mine to ensure that I educate myself, research the options, be wary of the other parties’ self-interest, and ultimately follow thru on the commitment.

Again, desperate times call for desperate measures. And job loss certainly qualifies. So I still claim no ethical high ground for those who must default on loans.

I just think it a mistake that those who, ignorant or not, made a deal now think the best way out is to simply walk away. It’s not that simple. And, my opinion is that they hurt themselves more than they know. A well-maintained home, current economy not withstanding, is never worth zero. And if the past U.S. economic trends of the past 100 years or so are any indication, those values will come back for those willing to stick it out past the rough patch.

Merriment's avatar

@robmandu – I agree with you that the homes, given enough time, will recover just as the economy will (oh please, please, please!). It’s people who aren’t in a position to ride that hard time out that have my sympathy.

I don’t accept ignorance as an excuse either, first time home buyer or not. But I do understand how some people’s “first time mistakes” are more drastic than my own and therefore I do feel compassion for the mess they find themselves in.

I also think, in this particular climate in which banks and lenders played a very large role, is making this lesson, which when I was purchasing my own home would have just been a needless “waste of money” that would have stunted my finances, into a desperate situation.

Again, I hear tell of people who are just walking on the debt in the same way that I heard many stories of people exploiting the bankruptcy laws…thing is I never met many of them “in the flesh” so I am somewhat skeptical that they aren’t a manifestation of the sour grapes on the part of the Lenders who are being hoisted on their own crooked business practices. Sometimes even the big guys have to pay the piper.

Zuma's avatar

The present foreclosure crisis wasn’t due to a sudden epidemic of ignorance or immorality on the part of borrowers. It was due to predatory lending practices. According to the FBI, 9 out of 10 under water mortgages were due to actionable fraud (the remaining 10% were speculators who got caught short). The Bush II Administration essentially created the sub-prime crisis through its Home Ownership Initiative, which encouraged lenders to target minority and unsophisticated low end borrowers, such as military families, and people with credit problems. Nonetheless, 55% of those getting subprime loans at inflated interest rates actually qualified for prime loans, but were told they only qualified for the higher interest loans.

The Administration signalled to the industry that they wouldn’t be regulated, knowing full well that the way that the way that banks, credit card companies and mortgage lenders make their money off this population is through stealth pricing or the trick and trap—practices that are commonplace on our checking accounts fees, credit cards, cell phone contracts, and now our mortgages.

The Federal Reserve, in the grip of free market ideology, gave the green light to securitize these loans and selling them on the secondary mortgage securities market. So, people whose word was good, got bundled together with people whose word wasn’t so good, and these got rebundled with other people whose word may or may not be good (who could tell?) creating a speculative bubble that was inflated by being rebundled and resold. When the bubble burst, it brought the whole banking, credit, insurance, and mortgage securities house of cards down. And it depressed real estate values upward of 20% to 30%, leaving many people under water.

The idea that these people are now obligated to live up to their word when they have been so abused by the fraudulent practices and speculative excesses of the whole industry is absolutely ridiculous, and amounts to adding insult to injury. Moral hazard does not attached to people who are the victims of fraud, whether it is directly or indirectly. And everyone who is now under water due to the bursting of the real estate bubble, is a victim of industry fraud, whether or not they were imprudent in getting into a subprime loan. For the most part, people were trusting and believed what their lenders were telling them. It is not their fault for not being sophisticated enough to see through the lies of the professionals they had—and should have had—every reason to believe and trust.

Rufus_T_Firefly's avatar

I think all would do well to remember the role that lender’s obscene profit margins had on many of the many loans going south. We have become a predatory nation with regards to how much profit is ethical and allowable. In addition, many new and older homes aren’t worth the monetary value assigned to them. Add that to ever-rising inflation and ballooning interest rates and it can quickly get out of hand and become home-buyer hell. I, for one, can’t blame anyone for wanting to own their own home, it’s far cheaper overall than renting and it offers a lot more security. Everyone deserves someplace to call home.

laureth's avatar

@Zuma – When I think walking away is unethical, I’m largely thinking of people for whom walking away is a voluntary choice (like this lady), not a result of being unable to afford it and losing it. At least, that’s what I assumed the question was about in the first place.

@LostInParadise – Do I think it makes sense for the mortgage holder to pay ten times what the house is worth? The question is sort of moot – they already agreed to it. They had the bank buy it for them and are paying back the bank. (Think about it this way – what if you borrowed the money from Grandma and didn’t want the house anymore? Would it be ethical to stick Grandma with it? Banks aren’t Grandma, but the principle is the same.) If you’re not willing to uphold your half of the deal, the house shouldn’t have been bought in the first place. So while it might not make financial sense, that doesn’t mean you can stick someone else with your mistake – at least, not ethically.

Also, since the market is glutted with foreclosed homes (and even ones that the bank wouldn’t take back) that don’t sell very easily, it could sit there for a long time with no one living there, and no one taking care of it. That’s why the value of the neighborhood goes down when homes are foreclosed.

Zuma's avatar

@laureth I think that the lady you cite is a perfect example of someone who was indirectly victimized by the greed and rapacity of lenders.

Why should she slave away to pay for a house that is worth almost half of what she paid for it, and which may never recover in value, when, through no fault of her own, the lending industry caused the housing market to collapse, sticking her with an asset that is declining in value that she can’t even sell? If she had the option of selling and getting her down-payment back, then maybe I would agree with you, but then there would be no harm and no foul anyway.

In this case, the woman forfeited her down-payment; so the bank not only gets her house, but a windfall in the form of her accumulated equity. After all, according to the terms of the deal, that forfeited equity is the bank’s security against just this sort of eventuality. If the bank didn’t want the house it could have modified the loan. But no, they were too greedy; so now, if they now have to share in her economic pain, that is only fair and just. It was they, after all, who are created the economic conditions and the incentives for her to walk away.

I actually cited the wrong Steven Colbert clip above. This the one where he lampoons the moral hazard argument you are advancing.

Here Steve Mecham, a community organizer in Dorchester, MA, explains in detail why the moral hazard argument is so pernicious and wrong.

Banks are not Grandma. Not even close. They are the most powerful lobby in the country. In fact, they are so powerful that they have gotten the usury laws repealed and the bankruptcy laws rewritten in their favor. Banks overcharge people; they engage in predatory practices; they act in bad faith, and they are so much more powerful than individuals, and the ordinary person is at such a disadvantage in dealing with them, that ordinary people are under NO moral obligation to them whatsoever, especially not to stay stuck in a bad deal.

laureth's avatar

So because the banks have done wrong, it makes it OK for people like you and me to do wrong? I guess I just don’t see it. [shrug]

I’ll be happy to agree to disagree with you, though. Usually I’m very behind the points you make on Fluther.

Zuma's avatar

@laureth Did you look at the links?

You are not doing wrong. When you walk away from from a bad deal you are trapped in (because you cannot sell) you are exercising the only option open to you under the contract—which is to surrender your accumulated equity (and take a substantial hit to your credit).

The bank really isn’t losing out on anything. They can deduct the loss from their taxes, and, believe me, they have seen to it that these write-offs are very lucrative. Plus, they get the house from which it can recover the money lent plus they get your (often considerable) equity nest egg. Why do you think the banks were so aggressive in foreclosing on people that they collapsed the housing market? That’s why you make a substantial down-payment—and why they require so much, depending on your credit worthiness.

If the bank really doesn’t want your house, it always has the option of modifying your loan so that it is more equitable fair. But even though they have been given thousands of dollars worth of incentives to do so under the Obama Mortgage Modification Initiative, they chose to jerk people around, and there is little people can do about it except walk away.

DrMC's avatar

@Zuma I guess I’ve been misinformed. I thought it was Clinton that started the mess, not Bush2. That would be giving Bush too much credit.

Am I still misinformed or is the media throwing a curve ball here?

YARNLADY's avatar

No, it’s not immoral to walk away from a mortgage when you were tricked into buying in the first place. However, it doesn’t make economic sense, because you most likely will have pay larger interest for everything you buy from now on, and settle for less than you want.

Plus, it is my understanding that you still own the difference between what the house brings in foreclosure and what you owed. If the lender chooses to forgive the difference on the loan, the IRS has decided it is the same as income, and will charge taxes on it.

It’s lose, lose, lose every which way.

Zuma's avatar

@DrMC The media is not throwing you a curve ball, you just have to keep reading till you get to the part where you find out what happened under Bush2. (see links above too)

Clinton did try to make lower income housing more affordable, but there were still regulations and, more importantly, regulators still in place; so “creative financing,” as it was called, never really got too far out of hand. It was also under Clinton (during his second term when he was trying to out-Republican the Republicans) that Congress repealed the Glass-Steagall Act in 1999. This removed the New Deal firewall between banking and securities speculation, setting the stage for bursting speculative securities bubbles to spread panic to the banking sector, and vice versa.

Fed Chairman, Alan Greenspan, in the single biggest mistake of his career, assured everyone there would be no problem in doing this because the new mortgage securities derivatives (that became so toxic later) spread the risk so far and wide that the system was safe against any foreseeable shocks.

However, it was under Bush2, and his Administration’s philosophical aversion to any form of regulatory oversight (see links above), that took the cops off the beat and allowed the really abusive, predatory lending practices to come in in full force. It was under Bush2 that lenders began aggressively foreclosing on the trick and trap products they sold in order to capture a windfall in the form of people’s home equity nest eggs. It was the rapacity of this rush to foreclose that pushed real estate market to the point of collapse, causing the (unregulated) mortgage securities markets to collapse, bringing down the credit default swaps (a form of insurance offered by AIG) and the bankers who were holding AIG’s bogus unregulated derivatives, and precipitated a banking crisis worldwide.

It was Treasury Secretary Paulson, under Bush2, that engineered a bailout that paid the banks (mostly Lehman Brothers and Goldman Sachs) 100 cents on the dollar for their toxic AIG assets—a rather generous deal for AIG and the banks but not so much for the taxpayer or the borrower. This, of course, did nothing to stop the foreclosures that are still rippling through the economy, despite some rather tepid and cosmetic Obama Administration initiatives purporting to assist mortgage owners to refinance or modify their loans, but actually providing a fee incentive bonanza for lenders who are not actually required to do very much in the way of actually modifying loans.

LostInParadise's avatar

Even if we ignore the culpability of banks in the current crisis, it is still the case that banks bear a responsibility to lend responsibly, which means not only that they should have reason to believe that the borrower will be able to make payments but also that the home will retain its value. The home after all is what secures the loan. Given the way that house prices kept escalating, there was good reason to believe that things could not continue that way and that a bubble burst was on its way. The banks took a risk and deserve to face the consequences.

Rufus_T_Firefly's avatar

The banks have forced at least one rule into into the mainstream and that rule is that there is precious little which is not subject to depreciation of value. Anyone who has ever bought a new car and traded-in their old one knows this. The automobile dealers most certainly know this and take full advantage of it. Likewise, insurance companies and personal property tax assessors know this. Why then, is it reasonable for a bank to expect a home, especially an older home, to retain it’s original sales value when nothing else on the planet does?

Zuma's avatar

@Rufus_T_Firefly “Why then, is it reasonable for a bank to expect a home, especially an older home, to retain it’s original sales value when nothing else on the planet does?”

Good question. For 60 years real estate did nothing but appreciate. There were times when the rate of appreciation may have stagnated, but there was never any appreciable length of time when they did not housing prices did not rise. And, considering that the population almost continues to grow while the supply of housing stock lags somewhat behind, there is a strong likelihood that they could have continued to rise forever, with periodic adjustments.

But the “trick and trap” provisions of mortgages being sold to millions of borrowers presented the lending industry with a unique opportunity to fleece the American public by rushing to foreclosure at the first sign of trouble. In some cases, they would even precipitate the crisis by failing to record payments correctly, or send them back because they weren’t the exact amount, then hit the homeowner with a number of back payments which must be paid all at once.

If they could rush through the foreclosure before the homeowner could refinance (an option they sabotaged by promptly reporting the homeowner’s late payments and default to credit agencies), they could often reap a substantial windfall by capturing the homeowner’s accumulated equity. So, when the economy hit a sudden downturn, and people started missing their payments, the rush to foreclose created a rush to sell that swamped the housing market with a glut that sent housing prices into a free-fall.

This is simple economics 101. The banks simply didn’t want to be the last one out, since the last one out gets caught holding the bag. So the continued—and continue—to foreclose because they have the resources to weather the storm. They can still get houses dirt cheap that will eventually come round again if they hold on to them long enough. It’s just the little people who get screwed in the process.

laureth's avatar

@Zuma – Yes, I looked at your links.

What I’m hearing is that if you surrender your house, you’re getting rid of a toxic investment that is worth nothing, but the bank wants the house because it’s a great investment and if they hold onto it, it’ll be worth something. Would it not still be worth something later if the borrower holds onto it too? You don’t actually realize a loss in value unless you try to refinance or sell (correct me if I’m wrong). So these people would have had the same trouble making the payments even if the house was still going for what they paid for it.

Investments are not always guaranteed to go up. Even if the bubble bursts because of the banks, everyone knows that property can go down. It’s something you know when you sign a mortgage, even if you’re not aware of the other tricksy bits that you’ve mentioned previously. To me, it’s not OK to walk away simply because the value has fallen. (Yes, the mortgage of the house I live in is underwater.) The bank is not breaking its contract to you because the value of your investment falls.

Now, if the question had been, “Is it ever a good idea to walk away” or “does it make sense to just let the house get foreclosed,” that would have elicited a different response from me. Similarly, I think it may sometimes be a good idea to steal food from a grocery store if that is a lesser evil than seeing your family starve. Does that make stealing moral? No. It’s still wrong; it’s just the less wrong thing to do. And if walking away from the promise to pay for the house is your only option, well, you gotta do what you gotta do, even if all the options you have are morally bankrupt (no pun intended).

rottenit's avatar

Business cut bad assets/inventments all of the time and chock it up to “Business decisions”

Zuma's avatar

@laureth “Would it not still be worth something later if the borrower holds onto it too?”

Sure, if you can afford to hang on to it. But, if the house is a millstone around your neck, pulling you deeper and deeper in debt—depleting your savings, your retirement, your life and health insurance, your car payments, why let a bad deal pull you under? That kind of thing can easily happen if you have an adjustable rate mortgage. If it goes up suddenly it can actually eat you alive. Why should you let it?

The bank can hold on to the property a lot longer than you can. It can wait until the market turns around. They make their money coming and going. It is touching that you are so solicitous of their welfare, but, believe me, they don’t give a shit about you.

You are not obligated to play every hand you are dealt. If you don’t like your cards, you can always fold. You lose your ante, but that’s what antes are for; they are the premium you pay for folding. It’s no different with an upside down mortgage. When you walk away, you lose your down-payment. There is no “theft” and no dishonor, especially not in a crooked game. The only reason you are under water in the first place is because the game is crooked. So why beat yourself up over a non-existent moral obligation?

Rufus_T_Firefly's avatar

”...mortgages being sold to millions of borrowers presented the lending industry with a unique opportunity to fleece the American public by rushing to foreclosure at the first sign of trouble.”

@Zuma – That was exactly my point. Although, I guess I could/should have just said so outright. It’s a money play and the general population loses out big-time to corporate greed. Over time, the lack of available housing is decreasing while demand is at an all-time high and new construction is moving at a snail’s pace due to the high cost of building materials or is completely nonexistent.
My parents bought their first decent home in 1971 for around $36k. About three years ago, that very same house was put on the market with an asking price of $112k. I know for a fact that neither of the two previous owners had put more than $20–25k worth of combined equity into the house when they decided to move and sold the house. The way things are, if I were a bank, I’d certainly be happy with a tidy little $51lk profit on a 61k investment. And the insurance industry thought they had a good scam working! The banks are the real profit pros.

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