Last week I talked about homeowners that are just walking away from their mortgages. This occurs most often when home values fall below the amount of their mortgage. In common vernacular, they are “upside down” in their homes. These individuals have not lost their jobs nor suffered a financial disaster; they are just walking away from their mortgages as a strategic move. They figure that since they have negative equity, they will just take the credit score hit and wait for the market to improve when they can purchase again and the foreclosure has dropped off of their record.
This is a very short-sighted decision to which the government is not contributing by bailing “over mortgaged” homeowners out. Under the law, there is a doctrine known as “sanctity of contract.” It is the doctrine on which much of our system of capitalism is based. In other words, if one signs a contract they are expected to live up to the terms of that contract or the law provides remedies for default.
Think about the consequences if there is no legal remedy for all the contracts we sign in our lives. For example, you borrow money to purchase a car and about 10 months into your note, the lender doubles the interest rate. Without sanctity of contract—the premise that both parties are bound to the terms of the contract—you have two choices, either pay the increase or surrender the car. Your common sense reaction would be to pay cash for your next car. Fool me once shame on you, fool me twice…
In the case of mortgages, if the lender is continually faced with homeowners walking away from their obligations, fool me once…. A reasonable business decision by the lender would be to increase the interest rates, increase the down payment requirements and place tighter qualifying restrictions on the next borrowers seeking home loans. Increased risk requires an increased reward for the lender.
The consequences of the lender’s business decision will result in fewer qualified buyers in the marketplace. Fewer qualified buyers in the market will demand reduced housing prices before they will purchase. As homes become harder to finance, prices will fall. I always like to ask this question. What would you have paid for your last car if you had paid cash? Most people would probably say $1,000-$2,000.—about the amount of money they paid as a down payment on the car they’re driving.
The natural consequence of homeowners “walking away” from their mortgages will hurt all of us in the long run. If the government forces lenders to change their mortgages to “help” “over mortgaged” individuals thus destroying the sanctity of contract, all of us will not only pay now but for decades to come.
Philip Crawford says:
What a bunch of propaganda. Homeowners are simply exercising their abilities to negotiate. This happens ALL the time in business and nobody, I mean NOBODY talks about “sanctity of contract”.
Did Morgan Stanley break the “Sanctity of Contract” here:
http://www.bloomberg.com/apps/news?pid=20601206&sid=a1ZCToo1eY3s
Because that’s what businesses do when they renegotiate the terms of an existing contract. Contracts aren’t guarantees.
Long story short. Banks made terrible lending decisions and so did borrowers. Many of those borrowers should strategically default. The have the right BY LAW to do so. Arguing otherwise is disingenuous.
18th February 2010 at 6:20 am
admin says:
I appreciate Philip’s comments. Regarding Morgan Stanley, unfortunately that is a different situation than your typical homeowner. In Morgan Stanley’s situation,the building was the only collateral for the loan. There was no personal guarantee so the only recourse the lender had was to take back the properties.
When a homebuyer signs a deed of trust or mortgage there is personal guarantee that the note will be paid regardless of the value of the home. In regards to the “right BY LAW’ to strategically default, I am not aware of that being the ‘LAW” in any of the 50 states.
If contracts do not mean anything, than lenders will not lend money because there is no recourse if the borrower defaults. Only borrowers that the lender was sure would repay would be able to borrow money. That situation would certainly damage our economy in the long run. Thanks for your thoughts.
18th February 2010 at 9:16 am