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Source link: http://archive.mises.org/16950/should-retirees-walk-away/

Should Retirees Walk Away?

May 15, 2011 by

There was a time when couples held mortgage burning parties.  The yoke that was a mortgage, on what was purely shelter from the weather, and a place to sleep and store your stuff, could finally be cast aside.

Before the decades-long run up in housing prices, fueled by government policies and government supported finance that engrained the American belief that housing values would never drop, mortgage was a dirty word:  A deal with the lending devil that a reasonable person would only do as a last result to own a home.  And to put a second mortgage on one’s home was a sign of fiscal imprudence in the extreme.

Now, as Robert Powell explains for MarketWatch, retirees are not only carrying mortgages, but many, may in fact owe more to their mortgage lenders than their homes are worth.   And given the huge over-hang of foreclosures that will over time reach the market, the punk economy, and lingering high unemployment, prices will likely continue to sink.

Fiserv Inc., which produces the Case-Shiller Housing Index, for instance, predicts home prices in retiree-rich Las Vegas to fall 14.2% this year and another 6.7% next year, despite the Sin City housing market already suffering a 56.7% drop from Q4 2005 through 2010.

When Powell asked Robert Webb at the Center for Retirement Research at Boston College what underwater retirees should do, Webb suggests a reasonable choice may be,  “Namely, to mail the keys to the lender.”

The advantages are an immediate increase in net worth, however, “In some states, the lender can pursue the former owner, and the household will take a serious hit to its credit score,” said Webb.

Neither Powell or Webb engages in the usual moralizing.  There is no discussion of setting a bad example by walking away or decreasing the value of your neighbors’ property if you mail the keys to your lender.

The decision is treated as a financial one:  What is best for the retiree to survive until death.  Why should an elderly person keep making payments on a home that for them will always be a liability and never an asset, just to prop up financial entities that are only operating today because the government keeps these too-big-to-fail entities in business?

The default moralizers will cry that retirees should do the right thing and honor their contracts. What kind of example are they setting for their children and grandchildren?

Meanwhile, what was the lender thinking making a 30-year mortgage to someone who surely would not live to make the 360 required payments?

The fact is lenders were playing the housing market.   Market values go up and go down.  How can these lenders plead to the courts that the loans they were making to Baby Boomers on the verge of retirement (or anyone else for that matter) were not just pure transactions to generate up front fees, using the assumption that the ultimate form of repayment was not a reliance on the income and cash flow of borrowers, but the sale of the assets that were the collateral for the loans?

{ 27 comments }

Shay May 15, 2011 at 2:25 pm

The default moralizers will cry that retirees should do the right thing and honor their contracts.

Is defaulting really breaking the contract, or is it simply invoking a different set of terms that were present in the original contract, put there specifically for this very situation? If so, it’s like the situation in the sports business covered recently here, and fully honoring the contract.

Steve Hogan May 15, 2011 at 2:25 pm

Yet another disastrous outcome from artificially cheap money. You’d think policy makers would have learned their lesson. Think again.

If Greenspan’s reckless monetary policy of holding interest rates at 1% for a year resulted in the largest asset bubble in world history, what are we in for with Bernanke setting them at 0% for 2.5 years and counting? The Great Correction is going to be a doozy.

Nonanonymouse May 15, 2011 at 2:31 pm

Walk away, exactly! It’s called strategic default, and it’s purely a business decision, the kind made every day in every line of business, and morality has zero to do with it.

If morality where to enter the discussion, where was the morality in driving up prices with easy credit, making sub prime loans, packaging and selling them as investment grade securities, bailing out TBTF banks when the economy went South, buying up toxic assets with public money, and adding $T’s to the public debt?

Strategic default should have been the decision by Bush in 2008 during the first credit crisis. but since he shewed his genetic lack of a backbone in Iraq and the credit crisis, we are where we are today, with $6.5T in private home equity, $T’s more in additional public debt, high unemployment, falling housing market, and a failing economy.

Balancing the federal budget and tax reform, both individual and corporate, is a way forward, but it’s only part of the story. Capitalism itself must change, and share profits with labor and a dollar for dollar basis.

Dave May 15, 2011 at 11:05 pm

Nonanonymouse, I have to agree with you on most points. The investment banks and the government rigged the game, and they sure never rigged it in favour of the taxpayer or consumer.

I disagree that you say capitalism must change. In the mortgage business capitalism never entered the situation. The Federal reserve and its member banks enjoy a monopoly on the creation [and destruction] of capital at no risk to themselves, as was evidenced in 2008.

Daniel May 15, 2011 at 11:42 pm

I’m sorry, did you say capitalism?

In this United States of America?

For the purposes of contrasting, let’s compare this capitalism of today with the 10 planks of the communist manifesto:
1. Abolition of private property and the application of all rent to public purpose.
- 14th Amendment
- Several zoning, school and property taxes
- Bureau of Land Management

2. A heavy progressive or graduated income tax.
- 16th Amendment
- Social Security Act of 1936
- Joint House Resolution 192 of 1933
- Various income taxes

3. Abolition of all rights of inheritance.
- Federal and state Estate Tax
- Reformed Probate Laws
- Limited inheritance via arbitrary inheritance tax statutes

4. Confiscation of the property of all emigrants and rebels
- Capital controls
- Civil asset forfeiture

5. Centralization of credit in the hands of the State, by means of a national bank with state capital and an exclusive monopoly
- The Federal Reserve, Federal Reserva Act of 1913
- All local banks are members of the Fed system and are regulated by the FDIC

6. Centralization of the means of communication and transportation in the hands of the State.
- FCC
- Department of Transportation mandated through the ICC Act of 1887
- Commissions Act of 1934
- Interstate Commerce Commission established in 1938
- Federal Aviation Administration
- Executive Orders 11490 and 10999
- State mandated driver’s licenses and DoT regulations

7. Extension of factories and instruments of production owned by the State, the bringing into
cultivation of waste lands, and the improvement of the soil generally in accordance with a
common plan.
- Corporate capacity
- Desert Entry Act
- Department of Agriculture
- Department of Commerce and Labor
- Depart of Interior
- EPA
- BLM again
- Bureau of Reclamation
- Bureau of Mines
- National Park Service

8. Equal liability of all to labor. Establishment of Industrial armies, especially for agriculture.
- Social Security Administration
- Department of Labor

9. Combination of agriculture with manufacturing industries; gradual abolition of the distinction between town and country by a more equable distribution of the population over the country.
- Planning Reorganization Act of 1949
(though I gotta recognize this would probably occur on a free market)

10. Free education for all children in government schools. Abolition of children’s factory labor in its present form. Combination of education with industrial production.
- Public School System
- Department of Education
- National Education Association

Law_Reader May 16, 2011 at 7:39 am

You stated the following
2. A heavy progressive or graduated income tax.
- 16th Amendment
- Social Security Act of 1936
- Joint House Resolution 192 of 1933
- Various income taxes

3. Abolition of all rights of inheritance.
- Federal and state Estate Tax
- Reformed Probate Laws
- Limited inheritance via arbitrary inheritance tax statutes

2. Refers to Subtitles A and C of the IRC (Title 26 United States Code) Subtitle A is income tax. Subtitle C is employment and wage taxes (socialist security). The difference between the two is as follows, and may not be an exhaustive list, Subtitle A is NOT voluntary and is withheld from non-resident aliens, foreign corporations, and foreign tax exempt (501(c)(3)) corporations. To withhold income tax you must be a ‘withholding agent,’ (see sections 7701 and 1461 of the IRC) to withhold and if you’re required to withhold you’re the one made liable for the tax. If you don’t pay you could go to jail. Oh and if you withhold money per the law under Subtitle A and you get sued the government will pay for your lawyer because you were acting as a lawful government agent at that time.
Subtitle C is100% Voluntary according to the law. If you wish to have money taken from your pay you must have a TIN or SSN, you must fill out a W-4, and the place paying you must have a EIN and want to make matching payments. Section 6211 shows the definition of a deficiency and it does not include Subtitle C taxes. If you get sued over withholding Subtitle C taxes the government will not defend you because you’re not acting as a lawful government agent.

In short the average citizen living and working within the 50 states of the union is not the subject of the income tax and the socialist security tax is voluntary.
Now for your inheritance tax issue. That is subtitle B of the IRC and again the average citizen is not the subject of that tax either. Read the annotated code at your local law library to gain a better understanding.

Daniel May 16, 2011 at 10:35 am

Thanks

If it is possible can you tell me on which grounds Peter’s Schiff’s father was arrested?

Law_Reader May 16, 2011 at 4:24 pm

Sorry I don’t follow every ‘guru’ out there I just read the law.

I remember something about an Irwin(?) Schiff is that who you’re talking about?

Was not he the guy that said to file a ‘zero’ return? If that is the case I think he was forced to file a return and because he did file a return it gave the IRS a case against him.

In short he was jailed not for any law violation but because the judges are corrupt and wish up to uphold the system and not the law.

Daniel May 16, 2011 at 10:37 pm

D:

Horst Muhlmann May 15, 2011 at 11:44 pm

Indeed. If your mortgage is held by Frenron (Fannie/Freddie) or one of the banks bailed out by TARP, you have no moral obligation to pay them a cent.

If anything, they have the moral obligation to forgive your loan.

Horst Muhlmann May 15, 2011 at 11:47 pm

One thing to add: I agree with Dan & Dave vis-a-vis Capitalism.

Tom May 15, 2011 at 3:01 pm

A mortgage exists as a contract. To default on a mortgage is defaulting on a contract. Defaulting on such a contract is not a death sentence, for either the lender or the borrower. The house is security for the loan. If it’s not worth enough to cover the amount owed on the mortgage, it is entirely possible for the borrower to setup a payment schedule, for some period of years, in order to make up the difference, in considerably smaller payments; normally this would wind up going to the company insuring the mortgage. This does not necessarily put a permanent black mark on a person’s credit history. When the difference is paid, both parties are whole again and any debts, resulting from the breached contract, are satisfied and the borrower now has learned a valuable lesson that, hopefully, will be applied to future purchasing considerations. When you take out a loan, you are a slave to the lender. Don’t take out such loans. You are buying something with money that you don’t have and placing a bet on the future economy; an economy that is increasingly run by the government. You know what that means. Modern commercial banking does not exist for the benefit of consumers. If you engage their services, then you may expect arrangements that protect their interests.

augusto May 15, 2011 at 4:12 pm

“Why should an elderly person keep making payments on a home that for them will always be a liability and never an asset, just to prop up financial entities that are only operating today because the government keeps these too-big-to-fail entities in business?”

I suppose one of the reasons is that you’d want to leave something for your heirs. When you walk away, it is as though you had spent the past X years paying rent (but as the comment above says: “The house is security for the loan. If it’s not worth enough to cover the amount owed on the mortgage, it is entirely possible for the borrower to setup a payment schedule, for some period of years, in order to make up the difference.”)

Of course finances is not everyone’s cup of tea, so the calculations involved are not easy, but a retiree (or a retired couple) can count on their children’s financial support, it might be a better solution to ask them to pay off the remainder of the mortgage (if possible as a lump sum), and actually own the house, which can then be put for sale for a low price.

Let me see if I can give an example (I’m not going to include interest and fees in the interest of clarity – and also because I’m no finance expert and I could be wrong):

Nominal mortgage – $1,000,000.00
Paid – $900,000.00
Current market value $500,000.00

I say: come up with $100,000,00, pay the morgtage, own the house. Put it on the market for anyone who offers $400,000.00, pay back whoever lent you $100,000.00 and use the $300,000.00 to buy a house somewhere in Uruguay and live comfortably for the rest of your life.

An alternative: if it was a family member (son or daughter) who lent you the money, then just put the house in his/her name.

I’d appreciate if someone could tell me what might be wrong with my reasoning on this.

Donald Rowe May 15, 2011 at 4:57 pm

augusto,

If you currently owe more than its current market value you are underwater, not if it is worth more than you owe, as in your example.

You could hope that its market value will return as inflation hits and you may be able to make the payments with your newly cheaper dollars. Perhaps, but you will also need more of the dollars that will be in your bigger paycheck to buy everything else you need. Overall its not a good situation to be in.

I hope this helps.

augusto May 15, 2011 at 6:39 pm

“If you currently owe more than its current market value you are underwater, not if it is worth more than you owe, as in your example.”

If I understand you correctly, you ignore what you already paid and calculate only whether the market value is more or less than what you still have to pay.

Thanks!

cheryl May 15, 2011 at 10:42 pm

In many cases, your remaining mortgage amount (the amount you STILL owe) is higher than the value of the home.

Original purchase price: $500,000
Morgage amount: $450,000 (assuming 10% down)
Monthly Payment: ~$2500 / month
After paying for the first 10 years:
Amount of principle paid off: $~85,000
Outstanding balance would be: $~365,000

If the current value of the home in this case is less than $365,000, the owner is underwater, meaning that they currently owe more than the home is worth, after taking into account the payments already made.
In a lot of cases right now, the value of the home is WAY below the outstanding mortgage value. If the owner continued to pay his morgage for the next 20 years, he would be paying almost $600,000 in interest and principle payments. If the home value is around $250,000, he could walk away and purchase another home down the street and be paying less. If he continued his payment amount of $2500, he would be paid off in about 12 years.

Shay May 16, 2011 at 2:31 pm

If the current value of the home in this case is less than $365,000, the owner is underwater, meaning that they currently owe more than the home is worth, after taking into account the payments already made.

Don’t you mean not taking into account the payments already made? The error is to take those into account, and thus keep paying, thinking you’d be losing something by defaulting, even though the amount you will pay from now until it’s paid off is greater than you’d pay if you had just bought the home off the market.

Donald Rowe May 16, 2011 at 3:22 pm

cheryl,

“. . .he would be paying almost [ XXXXX ] in interest and principle payments.” edits are mine

If we are going to include interest cost in our calculation, which makes us seem to be holding an asset that is worth even less, we must also include a calculation for rent payments that we will avoid by continuing to live in the house that we will not have sold but on which will be making payments, or the rent payments we could be earning from renting the house, if were we to live in a different place while retaining ownership of the house in question.

Rent may perhaps be much higher than interest because the interest portion of a mortgage decreases over the loan period, whereas a rent remains stable, accounting for inflation, as long as the property remains in usable condition.

This involves a large element of wild ass guesswork as to what the hypothetical rents would be both now and over time in a financial world that is prone to inflation.

I think that if we inflate above even five percent, that current interest payment may only be able to rent a cabana in the future.

Beware of internet advice in this, or anything else for that matter.

augusto, maybe you should look elsewhere for an answer for your specific question.

Cheers,
Don

J. Murray May 16, 2011 at 7:37 pm

Minor problem, rents aren’t stable. I’m paying less in rent today than I did 3 years ago. I’ve successively negotiated a reduction each year. This is possible because empty units to buy still impact rent prices. Additionally, being a landlord is no bed of roses considering rental properties get beat up and you have to maintain everything. A cost people tend to forget is maintenance, which averages around 2% of the home price, and the there are property taxes. That adds around $8,500 to the first year and both of these costs inflate year to year. You have to set rents at $708 a month just to cover the tax and maintenance. The rent on a $300k house would have to be set at $2,300 to break even, and with the intense competition on rental market, and the fact you could buy a nice house with that payment, its an impossible task.

For the elderly, renting isn’t a viable option based on how much trouble it is. The prestige of leaving real estate as an inheritance just isn’t worth the headache and real asset loss.

augusto May 16, 2011 at 8:27 pm

Don, thanks for your reply. Actually, I don`t have a personal stake on this – I don’t even live in the US. My question was prompted by what seemed to me ill advice: “just walk away”. But as your post indicates, this is not an easy decision to make, and the calculation involved is probably beyond the grasp of most people.

Donald Rowe May 17, 2011 at 8:15 pm

Thanks J.
Stable was the wrong word, but I failed to come up with one better. I meant to contrast rent with declining interest payments, and point out that inflation is the enemy of the retiree who must rent.

HL May 16, 2011 at 12:50 am

All decision making must be forward looking, taking into account useful historical data to the extent it helps planning. Sunk costs sully so much of the planning process. Don’t look backwards. Or, as Edna Mode says in the “Incredibles” movie: I never look back, darling! It distracts from the now.

As for “moral obligations” to fabricated fiduciary media pimp banks and the swindlers on wall street, I think that now, in 2011, it’s fair to say “hell no.”

Ray Rock May 16, 2011 at 12:37 pm

People seem to be forgetting that the mortgage contract isn’t the only governing document. There are a myriad of laws that vary by state that will affect the decision.

If you live in a state where a mortgage is a recourse loan you can walk away from the house, but you may not be able to easily walk away from your obligation to pay. Once the bank forecloses and sells for whatever they can get you will still owe the difference between what the house sold for and the amount of the loan. Not to mention all the interest and penalty fees that will accumulate during the process.

This is a decision that will have a lot of negative short-term and long-term consequences, so make sure you’re aware of all the ins and outs of your particular situation before making a decision to walk away.

If an old person walks away today his or her heirs may very well be surprised when the banks and bill collectors show up in probate court looking to get paid from the estate.

If you’re going to walk away make sure you plan accordingly.

Ori May 17, 2011 at 4:17 am

A very American problem, if I may butt it.

On this side of the Atlantic the mortgage lender can have a claim on your income even after you “walk away” or sell the house if the proceeds from the sale or teh value of the property is under the value of the remaining mortgage.

They may even have a claim on your soul if you read the fine print proper.

Losing your home would be a relief – the nightmare reality is:
1 losing your home AND
2 still seeing the instalments reduced from your bank account AND
3 starting to pay the rent elswhere AND
4 having a reduced credit score.

J. Murray May 17, 2011 at 5:32 am

That would be the case here (not claiming incomes, but reposessing and selling the house), but the problem is that nearly none of the mortgages have an identifiable owner. Our system sells it to a government sponsored enterprise (now outright government owned) Fannie Mae or Freddie Mac, which chops them up and sells them as securities, which are resold and shuffled around. Some 90% of the home mortgages in this country are government owned and nearly none of them can be tied back to an actual mortgage. A requirement for reposession is to establish ownership of the specific property. Because mortgages have been sold, securitized, and resold, establishing that link is almost impossible. All the bank that originated your mortgage does is collect your payment, take a cut, and shuffle the rest along to another entity. You can follow the money, but it tends to turn out that your single mortgage is partly owned by some hedge fund, a pension provider, a 401k, and some guy in Sheboygan, Wisonsin. And these are just the final securities. Whether the actual mortgage is owned by them, and not a loan backed by it at some point in the long chain, is hazy. The problem is compunded by the fact that none of the paperwork transferring ownership was done correctly. It’s become such a mess that no one is sure WHO owns that house, which makes walking away a low-risk proposition.

augusto May 17, 2011 at 7:28 pm

The only thing you know for sure is the house isn’t yours. :P

Virginia Llorca May 21, 2011 at 1:11 pm

In many cases, the fed provides an incentive to the mortgage holder in the form of cash for going with the deed in lieu of foreclosure, simply to keep one more house out of the foreclosure loop. See also blog “FICO says don’t walk away.”

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