Owners' 'strategic defaults' on mortgages depend largely on how far underwater they are

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That some underwater owners -- whose houses are worth less than what they owe -- are walking away from their homes even though they can still afford to make their mortgage payments has been well reported, if not well documented.

But just how prevalent are these "strategic defaults"? And what are the social and moral ramifications of jumping ship?

The answer to that first question is difficult to measure, if only because people who do make a conscious decision to ditch their mortgages, although they can still pay them, have every reason to disguise themselves as people who can no longer afford their loans. After all, if they can't make their payments, maybe Uncle Sam will ride to their rescue.

But research by three academics suggests that the willingness of people to default depends largely on just how far underwater they are. Or, as the study's authors put it, "People default because of the size of their negative equity, not just because they cannot afford to pay."

When the difference between what they owe and what their homes are worth is less than 10%, the researchers found that not one of the 1,000 U.S. households sampled said they would walk away.

And when the shortfall is between 10% and 20% of their home's value, Luigi Zingales of the University of Chicago, Paola Sapienza of Northwestern University and Luigi Guiso of the European University Institute found that just 5% of the owners they sampled would quit. Even when the difference reaches 50%, only 17% said they would throw in the towel.

There are some interesting variables. For example, although the biggest determinant is equity shortfall, another major consideration is people's attachment to their homes, with folks who bought more than five years ago far less likely to default.

Another economic driver is the cost to relocate, which increases with the number of years at the current location and the number of children in the family.

But no matter how the researchers sliced it, their findings indicate that there's hardly a stampede of underwater borrowers tossing their keys over to their lenders and moving on.

Indeed, the survey also discovered that moral and social variables tend to play a significant role in predicting strategic default. Zingales, who with Sapienza is coauthor of the quarterly Financial Trust Index, said "the most important barriers" to walking away might be both moral and social.

For example, people surveyed who believe it is immoral to default are 77% less likely to declare their intention to do so. At the same time, people who know others who already have defaulted are more likely to say they themselves would default.

Then there is something the study's authors call a "multiplication effect," meaning that the social pressure not to default is weakened when the borrower lives in an area with a large number of foreclosures. The predisposition to run away increases with the number of foreclosures in the same ZIP Code, the study found.

Factors such as age, education and political affiliation also play a role in the responses. Younger and older people are less likely to say it is morally reprehensible to default than middle-aged folk. People with a higher education are less likely to think defaulting is immoral, while people with higher incomes are more likely to say defaulting is immoral. There is little difference in the moral views among Democrats or Republicans, but independents are less inclined to say defaulting is immoral.

All of this is pure supposition, of course, because the findings are based only on declared intentions, not actual decisions. But the question of morality has generated quite a bit of discussion in the media, at cocktail parties and even in the real estate community.

Realty pros who responded to a question put forth by this column on RealTalk, an online community in which 30,000-plus members seek advice, voice their opinions and sometimes just vent, declared almost universally that walking away is unprincipled -- at least up to a point.

Nellie Arrington of Long & Foster Real Estate in Columbia, Md., says it is "morally wrong, legally wrong and just plain wrong" for an owner to walk away from a mortgage he can afford simply because the balance exceeds the value of the underlying property.

"Life doesn't come with guarantees," Arrington said.

Eileen Landau of Realty Executives in Naperville, Ill., says that while walking away may be smart from a financial perspective, "from an ethical perspective, I think it's dancing with the devil."

Although many agents sided with lenders, several say that banks in some cases are simply on the receiving end of their poor decisions not to work with borrowers.

Deede Wockenfuss of CybrSold Concepts in Chandler, Ariz., has had several clients who tried to no avail to work with lenders to get their loans modified. "The bank is asking the borrower to default," she said.

When push comes to shoving your loved ones out the door, Bob Hunt of Keller Williams O.C. Coastal Realty in San Clemente says the moral duty to protect your family outweighs the moral duty to repay the loan.

"Promise keeping is not the highest moral value," said Hunt, who before his real estate career taught ethics and logic at the University of Redlands. "If I promised to lend you my gun and you are now in a clearly dangerous psychotic stage, breaking my promise would be the right thing to do, not the wrong thing."

Hunt also believes that when it comes to mortgages, moral considerations carry more weight than they should.

"Mortgages are secured notes," Hunt said. "They are not like borrowing from your grandmother. If you willingly default on her, shame on you; she has no recourse. But if you default to the bank, it can take your property. That is the deal they made.

"The property may not be worth what they lent you, but whose fault is that? They are big boys and girls. They made a business decision, and in today's market, they lost. A deal is a deal."

Maybe so, but doesn't that work both ways?

lsichelman@aol.com

Distributed by United Feature Syndicate.

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