Are you stupid not to walk away from an "underwater" mortgage, even if you can make the payments?
White doesn't actually use the word "stupid" in his recent paper, "Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis." Instead, the University of Arizona prof blames emotion for clouding homeowners' judgment.
White asserts that the real reason more homeowners don't default is because of shame, guilt and fear, fed by misinformation about foreclosure's effects promulgated by the government, lenders and the media.
White doesn't just dismiss the idea that homeowners have a moral obligation to pay their debts. He thinks the idea of morality should be removed from their calculations entirely.
It's no wonder Washington Post columnist Kenneth Harney called White's treatise "incendiary." I can picture people's hair bursting into flame at the very idea of a law professor advising huge numbers of homeowners to strategically default.
Full disclosure: I'm one of the people White points to as trying to scare people into unnecessarily paying their mortgages. (I'm bemused by that, since so many readers think my writing about foreclosure and bankruptcy encourages people to abandon their obligations.) But that's not the only reason I found reading his paper to be a bit surreal.
White makes a number of valid points, and I'm sympathetic to his central theme: that lenders and the government are dumping the costs of the housing mess largely on the shoulders of homeowners, who are at a huge power disadvantage.
It's really worth taking the time to read White's paper in its entirety, and I encourage you to do so. But I'll provide the key points here -- along with why I think he's wrong.
What White gets rightMany homeowners would be financially better off walking away. There's no question that a good chunk of underwater homeowners likely would be richer in the long run if they abandoned their homes. Housing prices are unlikely to surge again soon, and it could be years, if not decades, before the value of some properties once again exceeds their loans. In the meantime, many people could save money by walking away and renting instead, or hitting the equity "reset" button by buying another house while they still have good credit and then defaulting on their earlier loan.
Foreclosure isn't the end of the world. Foreclosure's effects on your scores are severe (see "5 ways to kill your credit score") but can begin to fade almost immediately if you otherwise use credit responsibly. You won't be able to get another mortgage right away, but under current rules people with foreclosures on their records can qualify for Federal Housing Administration loans after three years, and most other lenders will consider you after five years.
(I strongly question White's assertion that most people could completely recover from foreclosure's impact on their credit scores within two years. At best, they would likely have fair, not good, credit by that point. With continued good behavior, though, their scores could return to prime or near-prime levels by the time the foreclosure dropped off their credit reports in seven years.)
Lenders are unlikely to pursue lawsuits in many cases. Some states don't allow lenders to sue homeowners for "deficiency balances," or the amount still owed on mortgages after a foreclosure. Even in states that do allow such recourse, lenders may not pursue the option because it's not financially worthwhile. The Internal Revenue Service isn't a worry for most homeowners either; the tax liability for forgiven debt on most home mortgages has been waived through 2012.
A lot of those lecturing about the immorality of walking away haven't got a leg to stand on. Lenders showed an astonishing lack of morality and responsibility by pushing risky loans. They could have redeemed themselves by getting serious about restructuring mortgages to make them affordable, but their efforts so far have been pathetic. Regulators, meanwhile, stood idly by while the foxes raided the henhouse, and lawmakers dropped the ball by not giving bankruptcy judges the power to modify home loans. (Bankruptcy judges already have the power to "cram down," or reduce, mortgage principals on rentals and vacation property but lack the ability to do so with mortgages on principal residences.)
White believes that the playing field won't be truly leveled and that lenders won't get serious about modifying mortgages until homeowners are willing in large numbers to simply walk away. But to do that, he writes, homeowners have to shed the pesky notion that they have some kind of moral or ethical obligation to pay what they owe.
"Individuals should not be artificially discouraged on the basis of 'morality' from making financially prudent decisions," White writes, "particularly when the party on the other side is amorally operating according to market norms and could have acted to protect itself by following prudent underwriting practices."