Underwater homeowners – The financial logic of walking away from your home loans
Why would a person decide to continue to make payments on a home where they owe more than what their home is worth (sometimes 50% or more)?
There are many reasons to do so, but is it really the right thing to do, to keep making payments (sometimes interest only!) for something that has little chance of building any equity in your lifetime?
You have the power to level the playing field with your lenders, but you have to be willing to walk away from the negotiating table. They think you won’t. They think you will feel guilty and ashamed. They’re banking on it.
I found an interesting study referenced in a post on Mish’s Global Economic Analysis, Government and Lender Policies of Fear and Shame Help Keep Homeowners Debt Slaves. University of Arizona law school professor, Brent T. White, published his discussion paper titled “Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis.” (pdf file, 54 pages – go to Mish’s post above for a good 3-4 page summary of the report).
From the paper:
This article proceeds as follows:
Section II shows that, despite widespread concern that underwater homeowners are simply walking away, the vast majority of underwater homeowners have not strategically defaulted on their mortgages.
Section III explores the financial logic of walking away from an underwater mortgage and suggests that many more homeowners should be strategically defaulting.
Section IV argues that though cognitive biases may account for many underwater homeowners’ decisions not to strategically default, emotions such as shame, guilt, and fear play the largest role in homeowner decisions to knowingly eschew “in the money” default options.
Section V argues that social control agents such as the government, the media, and the financial industry use both moral suasion and disinformation to cultivate these emotional constraints in homeowners. It also argues that credit rating agencies play a central role as enforcers of moral and social norms against walking away from one’s mortgage.
Section VI argues that the disparity between the norms governing the behavior of individuals and banks has created an imbalance in which individual homeowners have born a disproportionate financial burden from the housing collapse.
Section VII explores ways to either address the distributional inequalities of norm asymmetry or to empower homeowners to renegotiate underwater mortgages on a more level playing field with lenders.
UPDATE 1-7-09: New York Times Magazine, Sometimes it’s ok to walk away from your mortgage