small change toward a rich life

Mortgages: knowing when to walk away

In January 2011 Jak and I made a bold and controversial financial decision that would send our lives down a sharply different path. We decided to default on our mortgages.

For background, you should read my earlier post about buying our current house in 2006, around a year before the Seattle housing market peaked and began dropping.

By January 2011, the numbers were much worse:

  • We’d spent $179k on regular mortgage payments
  • We’d paid approximately $18k additional against principal on our second loan
  • We’d spent about $51k on house repairs and remodeling

dilapidated gingerbread house with 'Foreclosed' signTotal cost to date: $248k

Amount still owed on our two original mortgages: $363k

Value of house (Zillow estimate): $316k

So after putting nearly a quarter of a million dollars into this house, we were still $47k underwater on the loans.

And still sinking.

•   •   •

As of January 2011, it had been a little over two years since I’d lost my last full-time job, and another had not been forthcoming. I’d tried to bootstrap a software company, but had lost both my partners to economic necesssity. I’d gotten a little freelance work, but nothing long-term or steady.

Meanwhile, Jak had been employed more often than not, but with fluctuating wages and occasional months between contracts.

For the last 27 months, our income averaged roughly half what it had been when we bought the house. For those 27 months, our mortgage payments ate 65% of our after-tax income, or 56% of our gross income.

If you look at those numbers and think, ‘Hey, wouldn’t they qualify for that federal Making Home Affordable program?’ then yes, you would be correct.

The MHA program was supposed to help distressed homeowners stay in their homes by lowering interest rates and reducing monthly payments. Anyone who had bought a house before 2009, who was in financial hardship (including unemployment), and whose mortgage payment exceeded 31% of their monthly gross income was supposed to be eligible. But despite it being a government-created program, execution was voluntary and left entirely in the hands of the big-bank servicers. In our case, this meant Bank of America.

protest sign: Bank of America, bad for AmericaI spent a couple of weeks in 2009 putting together the considerable paperwork to apply. After a few months of radio silence, I started calling Bank of America. I spent hours upon hours on hold and being shuffled from person to person, each of whom told me something different. After months of trying to get someone to move us forward, we finally received a notice by mail that they didn’t have current paperwork (um, maybe because you’ve sat on it for a solid year?!?) and therefore our application was denied.

Swallowing my frustration, I started the application all over again. And once again, we got nowhere.

We were far from alone. ‘Lost documents’ and other avoidance tactics have been the servicers’ primary response to modification requests from day one.

The problem appears to be that the monetary incentive the government offers servicers pales in comparison to the fee payments those servicers get from the actual mortgage holders once a loan goes into default.

Bank of America didn’t want to modify our loans; they wanted us to default. Because they make more money that way.

I was starting to feel like the world’s biggest sucker.

•   •   •

I had been unemployed for most of the last two years, but I had not been idle. Among other things, I was on a rampant self-education crusade.

I had realized that, like most Americans, we had been making major life decisions based on information and advice that was simplistic at best and fallacious at worst. You know, pearls of wisdom like ‘mortgage debt is good debt’.

Looking at the state of our jobs, investments, and housing in early 2009, it was clear we’d paid an enormous price. I was determined that I would never be so naive again.

Seattle Public Library, Broadview branchSo I started studying. I devoured several nonfiction books a week, most weeks. (Let me say once again how much I love my public library.) Many of them were on economics and economic history. I learned — and am still learning — a lot of truly surprising things.

Eventually I had done enough research on the origin of the real estate bubble and the nature of the crash to have developed a sort of slow bitter rage at the financial industry. The unfettered greed of a relatively small number of people had devastated millions of lives.

On a more personal front, it was clear that the banks had no incentive to make any changes that would help us at all. ‘Squeeze until there’s nothing left, then toss ’em away and move on to the next poor sucker’ seemed to be the plan.

•   •   •

Although our emergency fund — once as high as $40,000 — was sorely depleted, it was not yet completely empty. The problem was that some major house repairs were overdue, and the only way we could pay for them was to drain what savings we had left.

ramshackle house, mostly underwaterIn January 2011 I sat down with a spreadsheet and ran some complicated projections. I came to the sickening conclusion that even if the real estate market improved much faster than the data suggested it would, by the time our youngest graduated high school in six years we would still be deeply underwater on the house.

We’d be 52 and 47 years old, stuck in a totally inappropriate house that we didn’t want, unable to sell or move. We’d have almost nothing in savings, because we’d been using our retirement money to make payments on the house. We’d have 19 years left on one crippling mortgage and — worse — the balloon payment on our 15-year second mortgage would be just four years away.

And that was the optimistic path, assuming that at least one of us could remain fully employed at all times and that we didn’t incur any major unforeseen expenses. Having spent the last of our emergency savings just to keep the house from falling apart, we’d be one calamity away from total bankruptcy.

•   •   •

Even then, if I had believed that we were in a ‘typical recession’ — a couple of tight years followed by an employment resurgence — we might have just kept on as we were, hoping that things would get better before we sank completely. But the more historical perspective I achieved, the more convinced I became that something fundamental had broken, and that our national economy would never again be the same.

sign: London Stocks Market, 1282-1737It’s difficult to conceive that all twenty-plus years of my personal economic experience — from the time as a teenager that I first started paying vague attention to the outside world, through my entire adult life to date — might be part of a bizarre thirty-year aberration. But everything I’ve learned about macroeconomics and history suggests exactly that.

I no longer believed we — as a nation, or as individuals — would ever be ‘bouncing back’ to the way things were pre-2008.

So, after two and a quarter years of holding it together on half our original income, we stopped paying our mortgages.

•   •   •

I know a lot of people struggle with the ethics of mortgage default. It’s been considered a Very Bad Thing in our culture for longer than most people have been alive.

check register, listing credit card payoffsAnd it’s something that just a few years earlier I could not have imagined doing. If we’d been generally inclined to run up a bunch of debt and walk away from it, we would have taken the bankruptcy option on our forty thousand dollars of credit card debt back in 2005. Instead we sucked it up, made the necessary sacrifices, and paid it all off.

But by January 2011, I had an entirely different perspective. First of all, this wasn’t just going to handicap us for a few years; this was going to cripple us for decades at least, and probably the rest of our lives. We had done absolutely nothing to deserve that fate.

Second, although we’d played by the rules, the banks had not even pretended to act in good faith. Corporations do not operate under a moral code, and will relentlessly pursue maximum profit at the expense of individuals who do.

No one was going to look out for us … except us.

And the idea that corporations are allowed to act exclusively in their own self-interest, but individuals who do the same are morally reprehensible? Just doesn’t hold water.

•   •   •

Before we missed that first payment in February 2011, I spent perhaps a hundred hours researching every aspect of mortgage default. I double- and triple-checked every legality to make sure that this would in fact be our best financial path, and could not leave us in an even worse situation.

It’s not entirely without risk. But then, neither was the path we were on.

Over a year later, my economic expectations are still proving accurate. Zillow’s estimate of our property value has dropped another $35k in the last 13 months. Unemployment figures are still high, and our personal job situation hasn’t improved.

More than ever, I believe we’re doing the right thing.

In future posts, I intend to detail my research into the legal and practical aspects of mortgage default. I’ll talk about the emotional repercussions, and the way that rethinking this one basic concept has led us to make even more radical, but positive, changes in our lives. I’ll talk about our experiences over the last year of default, and — when we get there — describe the process of foreclosure.

In the meantime, if you have questions, I’d love to hear them.


17 responses

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  1. Aaron says

    Thanks for sharing this with the world!

    Even though I knew this story, it is still awe-inspiring to read it now and think about what you went through, learned, and overcame. Seriously. I’m impressed. There’s more to the story yet to happen, and I hope it turns out well for you guys! I can’t stop thinking how smart and brave you are for doing all this!

    On a *completely* unrelated note: have you done research on good banking options for someone considering shifting away from Bank of America? :)

    • Karawynn says

      Aww, thanks Aaron. :)

      Re bank: sure, but my recommendation would depend on which features or services are important to you. Can you describe how you use your bank now (or would do, going forward)?

  2. Kokuanani says

    Congratulations to you for making this decision. “Businesses” make this sort of determination all the time, and they’re not shamed for it. In fact, it’s frequently lauded as a “practical business decision.”

    I’m sorry for the pain and worry you endured, but I applaud you for making this step for the good of your family. Thank you for writing about it. I hope more folks follow your exaple.

    • Karawynn says

      Thanks for the support! I do hope that more people will consider whether default is the best course for them, instead of just running their lives right into the ground over the idea that it would be ‘immoral’. If our example helps, awesome!

  3. Liz says

    I actually do not feel strategic default is similar to a business decision. When a business walks away from a mortgage it is because it was a nonrecourse loan, so the bank knew at the time it made the loan that it would be on the hook if the property fell in value. The bank worked that possibility into the pricing of the loan. If a business holds a property under a regular recourse loan (like a personal mortgage) it can only walk away if it does so in the context of a bankruptcy where the business is required to use whatever other assets it has to make good on its debts. In a strategic default the homeowner is hoping to hang onto their other assets, get out of the mortgage, and game the system a bit to get a free place to live for awhile. That is not something that was worked into the cost of the loan because legally the homeowner did not have a right to any of that- the bank viewed their primary risk on not getting paid to be if the homeowner was forced into bankruptcy. Of course no one has much sympathy for banks but this hurts all of us – taxpayer money goes into bailouts, mortgages are more expensive and harder to get, every home that goes into foreclosure further drags down the values of others in the area. It is such a widespread thing now that i think strategic default is losing its moral issues for many, but in the end it is still breaking a promise to pay a debt and then profiting by living in the home rent free for years. This is the part that bothers me most – you will make tens of thousands by living rent free for years, but when your house ultimately goes into foreclosure, housing prices on your street and neighborhood will likely also plummet. If your neighbor needs to sell around that time, he may take a thirty thousand dollar hit himself because of your foreclosure comparable even though he paid his mortgage every month, while you walk away with 30k in the bank. It is a difficult situation because it is so widespread and every person that defaults makes it more likely that others in the area will do the same, resulting in a nasty domino effect of plummetting home values. I do not know what the answer is, but i think it is important to recognize that it is not just a business decision and that every person that defaults sends ripple effects into the surrounding neighborhood and housing market in general. I am not saying that this wasnt the right choice for you but i think that it does have major moral elements and should really only be considered by people in pretty desperate situations. For that reason i do not think that it is OK for people to default just because they are signuficantly under water (i realize in your case that there were major employment issues so yours might qualify as a desperate situation – i just cringe when i hear people who can afford their payment talk about default – the bank never promised them the house would not lose value).

    • Karawynn says

      Lots to answer here, Liz. You’ve given a good overview of the nature of recourse and non-recourse loans. But you have a few mistaken assumptions regarding home mortgages and defaults.

      First of all, our primary mortgage actually is a non-recourse loan, under the laws of Washington state. You can bet the banks factored that in to all their mortgages in non-recourse states — and if for some reason they didn’t, that’s pretty much their own fault.

      Second, if you have a recourse loan, a ‘strategic default’ isn’t an automatic win. If you have other assets, the bank has the right to sue you for them. Your only defense then becomes, as you point out, bankruptcy.

      In a nutshell, that’s how we’re handling our second loan (which becomes a ‘sold-out junior’ after the first forecloses, and might — the legal precedent is a little uncertain — have recourse then). Jak and I do qualify for Chapter 7 bankruptcy, and our assets (outside of our retirement funds, which are inviolate) are minor enough that they are covered under the federal exemptions. So again, this falls squarely under your second scenario, and the bank should already have factored in that risk. (Especially since the banks’ own refusal to modify the loans is the only thing that pushed us to the brink of bankruptcy in the first place — we have no other debt.)

      I agree that the bailouts hurt taxpayers, but that was not something that the individual homeowner had any say in whatsoever. As far as the impact of declining property value on our neighbors, much of that has already happened — directly, as we lacked the money to complete the front landscaping we started in 2008, or replace the roof and make various other repairs — and indirectly, as many other houses around us have begun to be reclaimed. Even if we paid our mortgage right up until the point that we had nothing left and had to file bankruptcy anyway, none of that would change. Our neighbors would not be any better off. The only difference would be that the bank had those tens of thousands of dollars instead of us.

      ‘Living rent-free for years’ is also not a guarantee; it could have been as little as four or five months. The only reason it’s ever longer is because it’s to the bank’s accounting advantage to not foreclose on the property. In short, they don’t want it any more than we do. From the standpoint of property values, our continuing to live here in the interim is the best thing — at least we can mow the front lawn and keep people from breaking the windows.

      I don’t blame my foreclosed neighbor down the street for this property losing hundreds of thousands of dollars in value — I blame the banks. The housing crash is a systemic problem that rests on the shoulders of the financial institutions whose policies both created the housing bubble in the first place and then blew it up for their own gain — not on the shoulders of individual homeowners.

  4. BB says

    Glad to read this. We are in an almost identical situation and were advised by a real estate attorney, our CPA and several real estate agents that strategic default is our best and only option. I spent hours on the phone with B of A trying to see if modification or refi were options – totally denied on both accounts. First and foremost they wondered why I was even calling because we were current on payments. We stopped paying two months ago and it’s eating at me enough that I’m still reading and researching and finding stories like this one just to feel like hopefully I have made the right decision. Unfortunately it sounds like you have actually invested quite a bit more than we have in your home. I am basically looking at this like a really overpriced rental- especially when current rentals are going for less than half of our mortgage payment and for our monthly payment I could live in a waterfront house that is double the size.

    • Karawynn says

      BB, I hope you come to a place of peace about your decision. Given the agreement of so many professionals, it’s doubtless the best thing you could have done. I’m glad to provide what support I can!

      And yes, ‘overpriced rental’ is a good way to look at it, even for us.

  5. Geordie says

    I’m so relieved to have found your blog. I’m in North Carolina (also a non-recourse state) and am at the point, once again, where I am considering a “strategic default,” only this time, I think I am actually going to do it. I don’t technically owe more than the house is worth, but I have been unable to sell it – my last contract on the house fell through a week before closing because the buyers didn’t want to do the repairs the house will be needing (nor can I afford to do them, including replacing the roof). I can’t rent it for a price that will cover the mortgage, the local market won’t bear it. I have an interest-only loan, so, there is no equity in the house to loose. When I bought the house in 2007, I absolutely hands-down could afford it. In the recession, I lost about 50% of my investments (thank you, Merrill Lynch!), and now, at age 45, I will be working till I’m unable to; retirement is not a possibility for me. I have put at LEAST $50K into the house in renos and repairs, some of which to make the house more sell-able. I bought the house in 2007 for $310K and put a hefty 20% down. Now, the highest I can list for is $298,500K. A home a few doors down from me, comparable to mine just closed for $295K and the longer I sit on the market the more a price reduction is a reality. Every month that goes by is more money down the drain in payments that I will never see again, and I am drained of all my savings paying this mortgage and am, for the first time in YEARS gaining in credit card debt. I am already in my new house, that I love and can afford, with a fixed-rate mortgage. I have tried to do the honorable thing by holding on to this house, spending money to make it attractive to a buyer, and I have even rented it at times (at a loss), hoping the market would bounce back and I could sell and recoup my investment. That just isn’t happening. I would consider renting it long term even if it didn’t cover all if the mortgage, but, I simply can not afford the upcoming repairs the house will need. If I stay on the market longer, I might be able to sell the house with enough to pay off the mortgage, (thus sacrificing my $60K downpayment, plus the over $50K I’ve put into the house) but also what about the payments I’m making that I’m also loosing that I won’t see back? I just feel like I’m finally at the place to “stop the bleeding” and look out for myself. My mortgage is also with Bank of America and I’ve tried talking to them about modifications before and UG! I don’t know whether I should call them and see if they will do a “deed-in-lieu” or, just stop making payments and wait for them to call me.

    Did you just stop making payments, or did you call B of A and tell them you were planning on defaulting?

    • Karawynn says

      I just stopped making payments, and in fact have avoided all contact with anyone regarding the mortgage since. This was based on advice from the forums at loansafe.org.

      We are now at the 18-month mark; still no foreclosure.

  6. mare says

    If you stop making payments and they foreclose do you owe them any money?

  7. Kokuanani says

    If you read Karawynn’s initial post, and the subsequent responses, you’ll see that Washington is a “non-recourse” state — i.e., the lender CAN’T go after the homeowner/borrower beyond the value of the house.

    The bank/lender made a loan based on the value of the house. It “secured” that loan via its claim against the house. When the loan/mortgage isn’t paid, and the bank forecloses, the bank/lender Is limited to getting the house. It can’t go chasing the homeowner around the country for extra $$$$.

  8. T says

    I presume you’ve seen this and are surprised exactly zero?

    • Karawynn says

      I had not seen that particular development, so thank you for the pointer. Cheers for the whistleblowers, brave souls.

      Surprised? Not one whit, as that’s exactly what I suspected was going on.

      Vindicated? Oh, yes indeedy.

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  11. Mathieu Lebrun says

    Thank you for sharing. It’s very useful. Hope to hear more from you.

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