Some of the promises our government has made in the last few months about “helping people keep their homes” may actually worsen the housing crisis.
New proposals ignore the real danger associated with “strategic default,” when homeowners decide to stop paying their mortgage, even though they have enough money to make payments. The Obama administration is working to lower monthly mortgage payments, but as a recent study conducted at the University of Chicago points out, it is not necessarily high payments but negative equity in homes that drives default.
In the study, researchers found that “individuals who think the government should help homeowners who cannot make their mortgage payments are 12 percentage points less likely than the average homeowner to say strategic default is morally wrong.” The same study states that “26 percent of existing defaults are strategic.”
It is difficult to prove whether someone stopped making mortgage payments out of need or out of choice. The study discovered the true rate of strategic default by asking people at what point they would choose to walk away from their home instead of continuing to pay their mortgage. Was it when the value of their mortgage exceeded the value of their house by $50,000, $100,000, or $300,000? The survey found, “no household would default if the equity shortfall is less than 10 percent of the value of the home. Yet, 17 percent of households would default, even if they can afford the mortgage, when the equity shortfall reaches 50 percent” (emphasis added).
The problem of strategic default highlights one of the ways in which the current downturn is a function of ethical failure. Increasingly, the determination of when to default is not guided by the moral question: Is this the right thing to do? It is guided by the pragmatic concern: Am I too far underwater on my mortgage? Such difficulties are not easily addressed by legislation because they are deeply rooted in the moral culture in which the market operates. The University of Chicago survey found that important variables in predicting strategic default have nothing to do with money. “People who consider it immoral to default are 77 percent less likely to declare their intentions to do so, while people who know someone who defaulted are 82 percent more likely to declare their intentions to do so.” The more socially acceptable it becomes to default, the more likely people are to do it.
The bottom line: Choosing to walk away from a mortgage when you have the money to make payments is fraud. A contract has been signed, terms have been laid out, and a promise has been made. The biggest problem this survey shows us is not that 26 percent of defaults are strategic, but that Americans are not exactly sure if strategic default is wrong.
This moral weakness has concrete consequences. A mortgage company or bank loses money every time it forecloses on a house. Strategic defaults, which in almost every case lead to foreclosure, will lead to more financial loss to the mortgage industry. People living near someone who defaults can expect lower home values. It is a nasty cycle: As more homes go into foreclosure, more housing prices in the area drop, more people have negative equity in their homes, more defaults, and again, more foreclosures. When people who can still afford to keep their mortgage payments current choose to go into foreclosure, they do not just take money from their lender, they accelerate the decline of home values in their entire neighborhood and harm their community.
New legislation has done little to slow this cycle of foreclosure. The Obama administration is focusing on lower borrower payments, believing “that struggling borrowers will stay in their homes — even as values decline sharply — as long as they can make their monthly payments.” The solution the administration proposes is the Home Affordable Modification Program, or HAMP. This loan modification program specifically targets Fannie Mae and Freddie Mac loans, working to lower borrowers’ monthly payments to 31 percent or less of their monthly gross income. It does so by lowering interest rates, and, if necessary, extending maturity dates, using taxpayer money to make up the difference in the payments. It is the most complex and time-consuming loan modification system lenders have ever seen, and lenders who service Fannie Mae and Freddie Mac loans must comply with the new federal regulations or face serious fines and sanctions.
Obama’s plan is not forever. In five years, the payments that HAMP set will begin to rise again to meet the market interest rate. And if current trends continue, home equity will continue to fall for months and possibly years. This legislation is simply further distorting the correction necessary to right the market. Some struggling to keep up with their mortgage simply cannot afford the home they purchased and the false floor offered by HAMP only defers the inevitable. Others, the potential strategic defaulters, should make the sacrifices necessary to fulfill the contract they signed. Further tinkering with the mortgage market only continues the problems that got us into this crisis, and prolongs the time it will take to turn it around.