Walking Away from Underwater Homes

A phenomenon that we have witnessed with increased frequency lately is the act of homeowners walking away from their mortgaged homes. Not only is this a new phenomenon, but it is also quite disconcerting for the stability of the housing market. 

When a homeowner applies for a mortgage, the banks receive an appraisal on the home as part of the application process, and if accepted, homeowners are given loans for the appraisal amount or some fraction of the appraisal amount. Very commonly, homeowners must put down 10 or 20 percent of the appraised value and take a loan for the rest. During the years leading up to the crisis, however, it was not uncommon for mortgage lenders to give loans with no down payment at all.

In the ensuing years home prices declined at unparalleled rates and unheralded speed.  So what ensued were homeowners that had outstanding mortgages for far more than the home was now worth.  Homeowners were now on the hook for mortgages well exceeding the value of the home.  Understanding this, many homeowners simply walked away from their homes – leaving the home to be foreclosed.  

Two important conditions exacerbated this phenomenon. The first is economic; the less one is forced to down-pay on a home, the greater the chances that the home will go underwater (the home price will fall below the value of the mortgage), creating an incentive to walk away from the mortgage obligation. The second is moral; once upon a time homeowners would go to their local mortgage lender for a loan. It was a local mortgage lender, a small shop, where the homeowner received the mortgage. The in-person connection created an ethical obligation to repay the loan that was given to them. Today, most mortgage loans are made by large banks or even online.  People no longer feel the same moral obligation to repay a personal debt.