Is 'Intentional Foreclosure' Ethical?

Here's a question a reader asked Bankrate:

I bought a home two years ago that's now worth $120,000 less than I paid for it. Ouch! What's more, the bank won't touch a refinance. But I do have about $80,000 in savings. If I used it for a down payment to buy another home, then let the other go into foreclosure, could the bank come after the equity in the more recently bought home? Yes, it's a shady thing to do, but I feel it's my only option.

The response goes on to talk about what's ethical in personal finance and how it pertains to this situation. I won't give you their answer -- I thought it would be fun for all of us to give our thoughts on it instead. So, if someone is underwater on their home yet has money they could use to keep making the payments, is it ethical for them to let the house be foreclosed on and use their assets to buy another one?

Also, for a real-life example of how this might happen, check out The Foreclosure Crisis Hits Close to Home, Part 2.

Comments

[mb]

so what do you not like about the current house, aside from owing so much on it? if it is a good place to live, just stay there until the market improves, you have a roof over your head. no mention of not being able to pay the current morgage- so just stay put an make the house a home.

[Vincent Scordo]

From a moral perspective, it's clearly wrong to intentionally not make good on a written contract or agreement (the important thing to consider in the scenario you outlined in the post is that the homeowner has the cash to pay the mortgage). On the other hand, if the homeowner had no real cash to pay his/her mortgage but had the intention to pay if they had resources (and in turn went into foreclosure) then that would be morally ok, in my view.

[Greg]

I agree with mb...why not stay? Also, I hope the lender does due diligence. Finally, most lenders can call a note due immediately (they do not because they want your money, not your house). The person could end up with two foreclosures, no access to their $80k, and an inability to purchase or rent for seven years.

Oh, and as Vincent said, it would be morally wrong to do.

[segfault]

Whether the bank can obtain a deficiency judgment depends upon whether you live in a recourse or a non-recourse state. (Some states do not allow lenders to go after a borrower for deficiencies on a primary residence after they have foreclosed, others do.)

[cb]

"Yes, it's a shady thing to do, but I feel it's my only option."

Your only option? How about respecting the contract you signed and are clearly able to meet. The rest of us have to suffer because clowns like this didn't make fast money. He should be jailed and hopefully the bank is able to go after him if he somehow manages to get a 2nd place.

[Mike]

Why is being upside-down on a home such a big deal? Most folks are upside down on their automobiles before they drive off the lot and you don't see people abandoning cars on the side of the road because it's worth less than its loan amount.

Just curious as to whether being upside down on a house is different or just a psychological thing.

[Todd - Prosperity Junky]

Is this ethical? No. They agreed to pay a mortgage when they signed the document. They also agreed to the price when they purchased it knowing real estate can loose value.

Only option? Not true. As others said they can continue to pay their mortgage as agreed. Real estate, just like the stock market, will eventually turn around.

Just because they might find a legal loop hole, it does not mean it's ethical.

[Anom]

Don't think its ethical, but when you are dealing with unethical companies... whose counting? Dog eat dog.

[AJ]

Ethics aside, I also believe this is illegal. Doing this would require you showing documentation that you have the first residence rented to someone. Showing that documentation when there isn't a renter is mortgage fraud.

[Mark B.]

If you have no other choice but to walk away, then I think it is ethical to do so. It seems like this person does have the resources to continue paying this mortgage, so walking away would be unethical, and it would hurt all of his neighbors whose property values would drop as a result.

Now, if he was $120,000 underwater, with no savings, and had to move out of state for a job, etc. then I might be a bit more understanding.

I am about $55,000 underwater on my house right now, but I can afford the payments and do not have a NEED to move (even though I would like to). Since I can afford my payments, I am staying put and continuing to pay, however, if my job situation changed and I had to move out of state, I would be in trouble.

[Debbie c]

Wow, No wonder you americans are in trouble. Doeing unethical things like walking away from a morgage you can pay for is wrong. Why cant you just stay and ride it out? Oh wait, maybe you want a bigger better house! thank goodness im a Canadian!

[bob]

I have said it here before. Of course it is ethical.

Take the emotions out of the equation. They don't matter. A mortgage is a legal contract. That's it. not a favor. Not a moral test. Not a indicator of ethics. It is a simple legal contract.

It has several parts. The terms that both parties agree to, and the remedies if either party defaults on that agreement. That means that even through default, each party is fulfilling the next portions of the contract because that is the contracts purpose. That is why the loan has COLLATERAL.

Who cares why someone walks away. Their reasoning is irrelevant to anyone but them. It is about as important as why they have a particular cell phone, or a favorite color. It is their choice.

A mortgage is a choice. Entering it is a choice. Paying it is a choice, and not paying it is a choice.

It has nothing to do with ethics or morals. Those subjective descriptors don't matter. What is legal matters. And since what is legal is generally considered moral and ethical, there is your answer.

Too many people erronously assume that "breaking a contract" is unethical or "not paying" is immoral because you had an agreement in writing. Because you signed your name agreeing to pay. Blah Blah Blah.

People break contracts all the time. when they get divorced. When they change their order at the drive through. When they overdraw their checking account. When they cancel a subscription service, early terminate their cell phone plan, change insurance providers, speed while driving etc.

All these things require agreements, and many times agreements are broken. If you couldn't break agreements, no one would ever enter into them.

[JimL]

In many states the bank can come after you for the difference between what you owe and what they eventually sell the home for.

Unfortunately, some states make it difficult for banks to recover much, such as Texas. As a result, Texas is seeing a number of people coming to its state because of this very issue.

As said by others, this is unethical.

[Justin]

2 issues arise...

1) If he has enough savings and income to support an approval of a second mortgage by a bank, he surely has plenty or income to cover his current mortgage payment. Just because you're upside down now, doesn't mean you can just walk away. You agreed to buy the house at those terms. It's not your bank's fault.

2) When the bank sells the house for $100K less than the loan amount, you still have to come up w/ the $100K difference.

[Catherine]

There is no guarantee that the home buyer won't get underwater again on the next home, by which time he'll be out $80,000. The first house didn't simply go down in value by $120K, the buyer overpaid for it by some amount, possibly by the full $120,000. If the home he/she lives in is affordable month to month, the smart thing may be to stick with it.

When someone hits a rocky patch in their marriage, the absolute worst recommendation is for them to put out a personal ad and begin dating again. This is similar. Assuming the current home meets the family's needs in every other way and is affordable from month to month, then he/she should not look to spend down their remaining savings and take on new debt.

[Anom]

bob --

Couldn't have said it better myself. Good examples.

[Shaun]

I have to agree with bob here. No one is breaking a contract. In short your mortgage "contract" says "Pay on our schedule and we let you keep (and eventually own outright) the house, otherwise we take the house and trash your credit." By intentionally letting the house be foreclosed upon, the owner is making a choice which may or may not be financially prudent, but is not breaking any contracts.

[Jim]

It is unethical.

The mortgage is a contract. Purposefully defaulting on a contract that you don't have to just for financial gain would be unethical. If there was a financial hardship then thats a different matter, but in this case the person clearly doesn't have to go into foreclosure and is only considering it for financial gain.

@Debbie C. "you americans" includes over 300 million people with a wide variety of morals. You can see most people here consider this unethical. I bet we can find an occasional unethical act among the Canadian population too including some mortgage fraud:
http://www.mortgagefraud.org/canada/

@Bob, "And since what is legal is generally considered moral and ethical, there is your answer." Just because something is technically legal that does NOT make it ethical or moral. And vice versa just cause something is illegal doesn't mean its unethical or amoral.

Jim

[Ben]

That's perfectly ethical. It's a part of the risk the bank accepts.

[F]

Intentional foreclosure is nothing but taking advantage of a legal loophole at the cost of your (unlucky) business counterpart. You're a shark. Respect to those who wouldn't even be tempted - I know I would.

[James]

In this example, wouldn't the guy's credit go down the drain? He will have his "new" house since that transaction happened prior to the forclosure. But any borrowing he might need after that might be hard to come by?

Plus-- I think he's still on the hook for the difference between what is owed on the house and what the bank gets out of the house.

[LotharBot]

@the original post: If you have $80,000 in the bank and could afford to buy another house, walking away is not your "only option". Fulfilling your contract is an option. (Note that the guy didn't actually ask if it was ethical -- he admitted it was "shady" but asked what legal danger he might be in. Personally, if he does it I hope the bank launches a long and costly lawsuit even if they have no chance of winning. Because incentives matter.)

Consider the analogous scenario where you buy a brand-new $15,000 motorcycle. You go out and get in an accident and wreck the bike, and didn't have insurance. It is now worth considerably less than you paid for it. That doesn't mean you should "walk away" from it and stop making payments, going out and buying another bike quickly before your credit score drops. You should take the loss if there's any possible way you can. You should continue to make payments on the asset you agreed to purchase unless you actually reach a point where you can't do it any more.

@Ben: stores accept the risk of shoplifting. That doesn't make shoplifting ethical.

@Debbie c: Canada is a wonderful country. Your adverserial attitude tarnishes its reputation.

[CommRE]

Interesting discussion. My gut still tells me it is wrong, but Bob makes a good argument. He is right. Two parties have an agreement that includes options if there is a default. I don't see how it is a smart move, but it is simply an exercise of all of your options under the contract. Don't pay, and the lender takes the house.

Now, if the lender feels this isn't a fair deal (obviously the borrower thinks it is), then the lender needs to revisit the penalties for default. In theory, a default should reward the one left holding the bag with a premium.

[Todd]

No. There is no way to argue this. It is just wrong.

@Debbie c: Wow. How racist of you to make such comments against Americans! (According to members of parliment, nationality = race.) Also, we are still awaiting an apology for Nickleback.

[Lawrence]

As a Canadian I take some offence to Debbie's comment. Some people watch to much news and generalize too much.
Not all americans are greedy and bought to much house and canadians are far from perfect.Believe me debbie stupidity doesn't have borders.

@Todd

If you could please please not tell anyone else that Nickleback are Canadian, it would be appreciated.
I was hoping nobody would remember that.(I blame the governemnt for issuing them passports)

[Jay m.]

First why is the question of the ethic linked to theborrower's ability to pay. Is it not just as unethical for someone to default, even though it was beyond their control?

Having worked at a large bank the last time this mortgage debacle happened I found ethics has little to do with the bank's decision making. Its all dollars and cents to them. If you had mortgage insurance but had lost your job they would force you into bankruptcy so they can collect $10,000. Celerbrities who owed hundred's of thopusands and even millions were allowed to have work outs and short pays and walk away clean. This was because there was no upside like the measly $10,000 from an insurance policy for the bank to collect on.

Don't confuse personal ethics with sound financial advice. The BANKS DON"T.

Also, if you buy and then walk away your credit will take a hit even if the lender can not pursue you. But if you stay in teh same market you might be chasing your own tail, because when the market goes back up you will be positive again in he old house. You'll still make paper money in the new house, but have destroyed your credit.

[Noah]

Bob is exactly right. And Bob gave examples to back it up. All those "it's clearly unethical" and "of course it's immoral", why not throw some foundation onto those things that are so obvious and clear? If you're going to throw out a "your word is your bond" issue, please explain how that "if you default, XYZ happens" clause is the part of your word that should be ignored.

I'm happy to be convinced here, but saying it's "obvious" does no one any favors.

[Miss M]

Wow, none of you hang out on the LA Land blog, this has come up before over there with almost everyone taking Bob's stance. I'm surprised to see the opposite here. The contract has written into it remedies for if you fail to pay, both parties know the terms beforehand and enter the agreement willingly. You stop paying, the bank takes the house and damages your credit. In that discussion most people thought it was not a moral issue, only a contractual one. Whether the lender on the 1st property can come after him for the difference depends on the state, he will have a foreclosure on his credit report with all the negative consequences.

But personally, it's wrong. Look I've gotten caught up in this whole mess too, I'm underwater $100k maybe more. I wrote about being underwater on my blog, it got picked up by MSN Money. I suddenly started hearing from other homeowners in the same position, including ones who are thinking of walking away. It's a complicated issue, easy for armchair pundits to throw opinions around when you're not here with us.

[JimL]

Some of these comments really make me sick. Taking legalistic view points to justiy a way of not paying on a mortgage just because your asset is worth less is just plain wrong.

It is also upsetting in that people look at banks as just being some faceless organization that can take the beating, when in fact, it is the shareholders/bondholders that take it in the shorts.

Forgive me for some temper on this one as I had some bonds in both Lehmans and Wamu that were basically wiped out due to people that defaulted on their loans.

[Lord]

Since bad lending created this situation, I have little sympathy for lenders. They knew what they were doing even more than borrowers. Even if it is a non-recourse state, it would harm your credit though. Best to hold on until things hit bottom at least. If you become unemployed and have to move for work or transfer, it would then be a good time to buy there and let the bank have it back whether short sale, deed in lieu, or foreclosure. Real estate moves glacially, so you don't have to act rashly.

[Todd - Prosperity Junky]

If you default on a mortgage that is not unethical. You know the consequences and accept them. However, that is not the question here.

My earlier comment was that this is unethical is based on the assumption that you know you are defaulting on your current mortgage at the time you are applying for a new mortgage. This is dishonest. You are concealing information on your application. You are asking a new lender to loan you money on a second property while portraying that everything is in good standing with the first mortgage. Yet, in reality you are defaulting on the first mortgage. That has to be considered unethical.

[America]

[thank goodness im a Canadian!]

We're thankful, too! We like to keep our average IQ somewhere north of 100.

[Noah]

@Jim: You speculated and you lost. Blame yourself for taking on risk you apparently couldn't handle.

"It's wrong because it hurts me" is an honest answer, but it hardly evokes that moral outrage everyone else is citing to.

[kitty]

It is dishonest. Even if we were to accept Bob's argument about walking away - which I don't agree with, but it is beside the point - there is still the issue on their lying on a mortgage application for the new home.

Unless they can qualify for both mortgages, they will have to say on a mortgage application they plan to rent their old home out. Just saying may not be enough, they may need to show a one-year lease. I am not a lawyer, but it seems to me that lying on a legal document and faking a legal document can be considered a fraud.

It can also be a stupid decision - if one can afford the mortgage. When prices go down the price difference between cheaper and more expensive properties often goes down as well. 20% loss of value on an expensive house is more than 20% on a cheaper one... But when the prices start going up, more expensive places appreciate more. By moving to a cheaper place in a depressed market, one loses an opportunity for higher appreciation when the market turns and ruins one's credit in process.

[cherryblossom]

Forget about ethical for a minute and think realistically. What lender is going to give you a new home mortgage when you are upside down $100k on your current home. Only way it would work (and not very well) is if they bought a new place for $80k or less and used the cash savings for the purchase. Even then when you default on the old place you still get stuck for $100k when the bank sells it for less than what you owe then you get stuck for the balance. Not a smart move financially.

And as far as ethics go there is there anything ethical about the easy lending that the banks got away with for years. The banks and wall street got greedy and now they are getting burned.

[kitty]

@Jim L. "It is also upsetting in that people look at banks as just being some faceless organization that can take the beating, when in fact, it is the shareholders/bondholders that take it in the shorts. "
Not to mention tens of thousands, sometimes hundred thousands of employees most of whom had nothing to do with mortgages. It's not the top executives who made bad decision that suffer when banks fail. It's normal people - IT, secretaries, consultants, tellers that do. Then, it's employees, small stockholders and bondholders of companies that deal with banks e.g. sell them computers, software, office equipment.

Then there are all of us who lost a lot of money in this market. Some among us may end up losing a job before this is over. While most of the blame lies with the whole derivative mess (CDOs, CDOs squared; investment banks that bought those; SEC that allowed over-leveraging); people like this couple share some blame too.

[dan]

This is not easy to answer, I have been through this quite recently. I had to look at this with no emotion. We live in California, and bought our houses before "irrational" pricing took effect. We bought two homes we could afford. Long story short our investment home went back to the bank. Our personal home we kept, we got an exceptional deal on it @ $400K, we now owe a bit less than that. The house next door just sold for $130K. In round numbers based on the average home doubleing every 10 years it will be at least 30 years to break even. Not a pretty picture. If I could I would walk away. It is the only option as bank's will not work with you, as it's not their fault. Honest people who played by the rules are getting burned by a system that rewards greed, and penalizes sane long term thinking.

[Sarah]

I don't understand why people think this is unethical.

When you signed your mortgage, you did not agree to make payments every month on your mortgage. You didn't even agree to do it "except in cases of extreme financial need." What you agreed with your bank was that you would do one of two things. Either (a) you make your monthly payments and stay in your home, or (b) you do not, and the bank gets the title to your home. Both options are clearly spelled out in the contract (and addressed in the state property law). If you choose to exercise option (b), you are fulfilling the terms of your contract, not skating through some "loophole." The mortgagor is not some innocent who had no idea that people can default on their mortgages--it's a company, doubtless advised by lawyers, who thinks the risk is worth it.

In fact, THE MORTGAGOR IS BEING COMPENSATED FOR TAKING THE RISK OF YOUR DEFAULTING FROM THE MOMENT YOU START PAYMENTS. Why, exactly, do people think that you have to pay a higher interest rate for your mortgage if your credit score is lower? It's because you're seen as a greater risk to default, and thus you are paying extra money to the mortgagor every month to compensate for that risk! (Not to mention PMI.) In other words, you are giving the bank extra money precisely because you have option (b). You have bought and paid for that option. Why is it immoral to take it?

My point, then, is not merely that the action is moral because it's legal. I don't think that legality is always sufficient to secure morality. My point is that your action is moral because you are honoring your word. You are doing precisely what you agreed to do and what you paid to have the right to do, openly and honestly. Deals in contracts go south all the time. In general, just because the bank suddenly doesn't find the terms of the contract attractive doesn't mean you have to give up your rights.

[Sarah]

(Although I should say that Todd has a point--any fraud involved with applying for the second mortgage would be illegal and immoral. I don't know if the poster would have to commit fraud to get the second mortgage, however.)

[JimL]

Kitty,

Thanks for adding those comments. Additionally, when you let your home fall into foreclosure, you negatively impact the value of your neighbors home as the bank will have to sell it at a distressed price.

Noah - I took the risk. The acceptable risk is when people default as a result of job loss, etc. However, when people just bale on an obligation because they think it will come out better economically, it just plain wrong and unethitcal.

Here is another way of looking at it. Let's say a contractor signs on to build you a home. You give him $100,000 upfront after signing a contract. The contractor then decides it is better off for him economically to take your money versus building you a home. Based on some of the comments above, you would think that is all fine and ethical. No wonder our economy is where it is today. We have too many people not willing to live up to the committments they have made.

[Anom]

JimL - Did the contractor add in a provision that allows him to do that? Because, if not, it is illegal.

As Sarah put it... mortgages are written and drafted so that their is a price put on your ability to walk away. Interest and PMI are there for a reason...

[JimL]

Anom & Others:

The question posed is if this is ethical. Many of you are purely looking at the legal portion versus ethical portion.

Once again, is INTENTIONAL foreclosure ethical.

I deal with contracts everyday. There are always options and ramifications as to non-performance on contracts. We can set around and debate legal merits all day long. However, this is not the question that is posed here. Please consider your position once again.

[bob]

Jim & others

I am looking at the legal portion becasue that is all there is to look at. The legal aspect is the only thing that matters.

The question is should the borrower buy another home, then let his current home go into forclosure and the ethics involved.

When he buys the new home, he will not be lying when he signs his intention for that to be his primary residence. No ethical issues yet. He will have to qualify for both payments, but assuming he does, he will have no issues with financing another home. Happens every day.

His old home, the one he is contemplating "walking away" from. When he signed the loan paperwork for that one, he was signing in good faith at that time as well, so no ethical issues there.

Things happen, and circumstances change, but what matters is the intention at the time of signing. As long as he doesn't walk away from the "new" house, what he intends to do with the other home is of no consequece as long as he has the ability to pay.

If he then chooses to stop paying on the old loan, the default portion of that contract kicks in as it was designed and he pays the consequences.

Banks have risk premium baked in. Banks have no way of knowing whether you will continue to pay your house payment after you close. It is statistical risk measuring. That is why they use history and credit scores. Predictors of risk.

That does not mean that after closing, borrowers have not lost their jobs, died, been disabled or have somehow been unable to make their payment. This happens often as well.

But, it is not unethical, as looking for a different job while you still work in your current one is not unethical. In fact, it is prudent. It is called getting your ducks in a row before a major change in your life, and responsible people do it every day.

This guy isn't dumb. He is smart and he is acting with prudence.

[CC]

I can definitely see both sides of the issue.

Part of the reason people find this so unethical is because this behavior has an indirect effect on the "honest folk". I'm one of those honest people who doesn't particularly want to see my home value decrease because of foreclosures and future financing costs increase because of the added risk of this behavior.

I also find it interesting that while this behavior is not "illegal" if the banks owning these loans decided to collect on the remaining balances of good loans to help pay for the bad loans would we not be screaming at the gov't for this illegal and unethical behavior to stop. Stay with me here. A bank needs cash so perhaps the bank decides to get out of the lending business with you despite your payment history. You now must find a new loan and perhaps have to put up extra money or let the bank foreclose on your home. How is that any different from what is being suggested? It's not the best way for a bank to run its business and unlikely to happen but I throw the question out there as devil's advocate. How many would be screaming to their local politicians? As homeowners, we have quite a few protections - shouldn't the banks have some of the same basic protections?

I can't call this behavior smart and sincerely hope people who execute on ths strategy get burned. I tend to call it unethical because I have to pay for someone else's gain.

[JimL]

Bob,

The question posed was not legal. By even inserting into your post, you are biasing the message. Shouldn't it become unethical when the person causes harm to someone else. With mounting loses from the homes going into foreclosure, banks will need to lay off more people. This person would play a part on someone losing their job. Secondly, the neighbors of this homeowner will suffer by diminished home values as foreclosed homes are often sold at low values in order to get rid of them.

In the end, other people will suffer as a result of this person looking to improve his financial position.

[Noah]

Which is exactly what banks do. And don't forget, they -wrote- the contracts.

Noah,

You are not forced to sign the contract. Mortgages, for the most part, are very straight forward. They give you money and you agree to repay (unless you decide to take the unethical route).

[Sarah]

6:45--do you have a mortgage? Do you genuinely not understand that you are legally obliged to do one of two things by your mortgage and/or state property law: repay *or* give up any claim to the title of the home? Are the same people who bitterly castigate others for not fully informing themselves about how much their mortgages could end up costing now demonstrating that deep an ignorance of the terms of their own mortgages?

And everyone saying that it shouldn't be done because it might hurt the neighborhood--are you the same folks defending everything the so-called free market has done to the nation in the past decade? Arguing against regulation because businesses should be free to do what they want? It's okay for Wal-Mart to move into an area, undercut local businesses, and pay people miserable wages under miserable conditions because that's what the market will bear, but an individual voluntary foreclosure is unthinkable? Or was it just in the end that the Wal-Mart thing hurts those nasty poor people, and the foreclosures hurt your property value?

No wonder corporate America gets over so often. Corporations breach contracts every day, and no one even seems to be aware of it, but God forbid an individual person exercise the rights he has under a contract with a far more sophisticated party. Sheesh.

Sarah,

Once again, your post just goes off into a different direction. Do you have an opinion as to the subject that was raised? Do you think it is ethical for the person to intentionally bail on his/her mortgage? If you want to talk about WalMart, ask to start a thread on that one.

[SAHM]

I find this sad that foreclosure is becoming so acceptable in our society. Just a few years ago, it was very shameful.

I believe it is unethical to just walk away. I don't care what is "legal" because there are many things that are legal that are not necessarily ethical. I believe that a big part of what is wrong with our country is people more concerned with what is "legal" and what they can get away with rather than what is right and ethical.