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Jack M. Guttentag The Mortgage Professor

Jack M. Guttentag, The Mortgage Professor

Mortgage Fright and Moral Quandaries

by Jack M. Guttentag

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Posted on Wednesday, October 22, 2008, 12:00AM

The mortgage world has suddenly become very frightening to many people who have no real reason to be frightened. Their mortgages are in good standing, they are not having any trouble meeting their payments, yet they are in distress -- in large part because so many around them are in distress. Fear is contagious. The only antidote I know to fear is good information.

One important thing that people suffering from mortgage fright often forget is that a mortgage loan is a contract between two parties, and it cannot be violated by either without the permission of the other. If the loan is sold, the purchaser replaces the originating lender as the contracting party and is subject to the contract in the same way. If the servicing of the loan is sold, the servicer as the agent of the owner is required to abide by the terms of the contract, and the same holds if the loan is placed in a pool as collateral for a mortgage-backed security.

The two letters below are from borrowers who do not have a problem with their current mortgages but are distressed about what might happen in the future.

"Crazy Things Are Happening"

"Can whoever owns my mortgage demand immediate repayment of the balance? I know it doesn't make sense, but crazy things seem to be happening..."

Mortgage contracts do not give the lender the right to demand immediate repayment. Balloon loans require repayment at the end of the balloon period, but that is stated in the contract. Fortunately, there are not too many balloon loans around.

Even if lenders had the legal right to demand immediate repayment, they wouldn't do it because it would only generate more foreclosures. For the same reason, borrowers with balloon loans in good standing who are unable to refinance anywhere else will find that their existing lender will prefer to refinance them than to foreclose.

A Rate Is Adjustable -- Not the Index

"When the rate on my ARM (adjustable-rate mortgage) adjusts next year, the new rate should be the one-year Treasury rate at the time, plus a margin of 2.5 percent. Last year, however, my lender replaced the Treasury rate on new loans with Libor. Because of the crisis, Libor is now 2.5 percent higher than Treasury. Can my lender switch my ARM to Libor when my rate is adjusted?"

No way. The rate is adjustable but not the index used to calculate it. Your ARM contract stipulates the index and its source, and the only circumstance in which a different index can be substituted is in the event the specified index is no longer available. The different Treasury indexes used by ARMs are compiled by the Federal Reserve and there is zero likelihood that they will disappear.

When a Borrower Is Upside Down

I wish I could answer the next letter with the same degree of certainty.

"We bought our house just last year with 100 percent financing; now it is worth $40,000 less than we owe. I don't know what to do. Do we keep making mortgage payments or do we stop? A friend has advised us to lock the door and send the key to the lender, but that doesn't sit very well with me. We've always met our obligations and have good credit. What do you advise?"

This letter is typical of many I have received from borrowers who are "upside down" in owing more than their houses are worth. I have a lot of trouble dealing with it because in good part it is a moral issue.

My right-handed side says that when you borrow money, you should pay it back if you can. During the many years when house prices were rising, he never once heard of a mortgage borrower offering to share the capital gain with the lender. There is no justification in forcing the lender to share the capital loss.

My left-handed side rejoins that very few of the people who are upside down today enjoyed a capital gain on previous homes that they owned. Further, the borrower's major obligation is to his family, not to his lender. If the financial gain from letting the house go to foreclosure more than offsets the pain of having their credit trashed and having to find a new place to live, then that is what the borrower should do.

There is an economic dimension to this quandary. If those who are upside down could be assured that house prices had hit bottom and within a year or two they will be right side up, there is little doubt that most would elect to stay the course. Unfortunately, no economist in good conscience can provide such assurance today.

Finally, there is a policy dimension. Upside down borrowers would be encouraged to stay the course if they had some reason to believe that the government will help them get right side up. Right now, the prospects for this are extremely murky. But don't write the possibility off just yet.

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220 Comments

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  • Robin - Tuesday, October 28, 2008, 7:28AM ET  Report Abuse

    • Overall: 3/5

    Smart, happy people buy a HOME in which to live. Fools buy a HOUSE for a so-called "investment". www.fairtax.org

  • Yahoo! Finance User - Tuesday, October 28, 2008, 12:08AM ET  Report Abuse

    • Overall: 3/5

    The ONLY thing that caused this crisis is stated income loans. If you don't know what this is then you should read about it before you can truly understand why this is a crisis. I believe we still would have had a small bubble, but it would not have brought down global economies.

  • Yahoo! Finance User - Monday, October 27, 2008, 10:52PM ET  Report Abuse

    • Overall: 3/5

    The deal is pay your morgage or the bank gets the house back. Why the big deal about giving the house back. That is what is supposed o happen. You don't make your car payment they take it back, same with a house. Am I supposed to feel sorry for a bank? We made a deal. I will pay them every month. If I quit doing that, they get the house back and in my mind we are all square. The house was what the bank asked for collateral.

  • Danny - Monday, October 27, 2008, 5:43PM ET  Report Abuse

    • Overall: 1/5

    BAD ADVICE! We are only talking about $40K here... Consider it the Down Payment that should have been collected. Who ever said that any "Investment" could not go up and down with time??

  • HopeNow - Monday, October 27, 2008, 11:55AM ET  Report Abuse

    • Overall: 1/5

    Sad advice from the left. Morality is not the question. Unless the borrower signed the mortgage at the point of a gun they are contemplating theft. The "value" of the house is irrelevant. It has no impact on the monthly mortgage payments required by the mortgage contract. If the borrower is now going to walk away from their obligation they will not be able to rent another home without considerable expense, as their credit rating will be severely damaged. In this economy someone who is so uninformed and amoral enough to pose such a scenario is also likely to lose their job. With a shattered credit rating in such a competitive climate they not be hired by a new employer. They will lose any medical coverage they have and will be out on the street. If anyone other than the smallest percentage of Americans(

  • Yahoo! Finance User - Monday, October 27, 2008, 8:40AM ET  Report Abuse

    • Overall: 3/5

    There are a lot of folks who cannot pay cause of death loss of job etc. thats understandable. People who took mortgages whether subprime or other ways why did you do it in the first place just to say you have a home and these banks etc giving them should be ashamed too. americans live beyond their means. what a mess.

  • Guardian - Sunday, October 26, 2008, 11:09PM ET  Report Abuse

    • Overall: 3/5

    The list of blame re this melt down is long. However, to let the system ( banks, wall street, brokers etc) collapse would cause financial anarchy world wide. Re: upside down. The only time one should care what the value of you home is when you sell it. Other wise it is where you live. It's not an atm machine.

  • Yahoo! Finance User - Sunday, October 26, 2008, 1:01PM ET  Report Abuse

    • Overall: 2/5

    What alot of you are missing is that average americans that bought a house over 7-10 years ago with a fixed rate mortgage and the rate of inflation has exceeded the raises you may have recieve over the same 7-10 years are the next wave of forclousures. People that have paid there debt and bills on time and not over extended themselves. The Gov. has really messed this up with de-regulation. Democrates wanted everyone to own a home back in the Clinton era and this is the result. I think that the people commenting who actually think they can pay their bills on time now are in for a world of hurt and we will see if you are still singing the same tune when you are in the situation because the ecomony has fallen around you. This affects everybody even the rich. The banks and gov. are setting the example. Books don't balance, ask gov for money. These institutions should be left to fail. Why was that 10 years ago, if you didn't qualify you couldn't get a loan? Because it is the only way for the bank to make money. These banks killed themselves and noboby wants to comment about that. I do have to agree though, leaving your obligation just because the house is "upside down" is a horrible reason to leave. I just don't think that is the reason they are leaving. They are leaving because they can't afford it and the bank should be just as penalized for the loan to someone who couldn't afford it.

  • John - Sunday, October 26, 2008, 8:58AM ET  Report Abuse

    • Overall: 3/5

    We need to help these people stay in their upside down homes, by offering them 40 year mortgages. We work longer and live longer than our grandparents yet we still use a 30 year instrument. While this approach doesn't turn the mortgate right side up. It allows time for the equity to rebuild. If it doesn't turn, then the banks are renting the homes to forestall the foreclosure.

  • bodo - Saturday, October 25, 2008, 11:56PM ET  Report Abuse

    • Overall: 1/5

    I question the morals of someone who enters into a contract and then, because the economics of his chosen deal reverse, has to ask if it's OK to unilaterally break the contract. Fine, go ahead and default on your mortgage. Just don’t ask me to ever do business with you or hire you as an employee.

  • Deedubyah - Saturday, October 25, 2008, 3:46AM ET  Report Abuse

    • Overall: 1/5

    Foreclosing on your home is NEVER a good idea. The long term impact on your credit is beyond repair. Especially with what banks will impose after this is over. That he would even suggest that it is a good idea shows that he is out of touch with the whole of the market. Even if you owe more than your home is worth, and that does suck big time, you borrowed some amount of money and you need to pay it back. Example, You borrow 100 dollars from me in the form of a loan with a 5% fixed return (i get 105$ back), and buy clothes a week before black friday (day after thanksgiving). On black friday the clothes that you bought are suddenly 25% off. What do you do? You realize that you made a bad purchase, or that something unforseeable has happened and you pay me the 105$ not 78.75$. if you only pay me the 78.75, I am never going to lend you money again because you stole 26.25 from me. The idea that you only pay what somethign is worth is absurd. you pay what you agree to pay. imagine if this were true with employers. Well Deedubyah, we find that you are only worth 15k this year, so we cut your pay. perhaps next year your work will be worth more right? You signed a contract and got a bad deal due to poor fiscal practice by the Financial Institutions. You are still under contract, and to ignore that and foreclose or default when you are able to pay is the worst course of action. It would be more appropriate to try to renegotiate your contract with legal help. The bank sells you a house for 100k then a few months later says the house is only worth 60k. Find some legal ground to reduce somethign. lower your interest, negotiate an interest hold for one year and only pay prinicipal, a 0% deal. Be creative. Their best option is to consider your offer rather than foreclose. Think about it. bad credit condemns you in America. no student loans, no car loans, no morgage loans, high interest. If you make subprime, you will be getting nothing in the future.

  • Yahoo! Finance User - Saturday, October 25, 2008, 1:27AM ET  Report Abuse

    • Overall: 1/5

    Why is it in 2005 I could of bought a house but didnt. Houses on long island at the time cost 550k - 650k for a piece of junk and incomes were in the 60k - 75k range. Now you have to be an idiot to think you can afford that and shame on you if you fell into the trap. As for banks, they are at fault on creating a credit bubble. Im sick of getting mail every day to sign up for a credit card. Im sick of going to macys or any store and everytime I check out I get asked if I want to sign up for a macys credit card or a barnes and noble credit card. Its sickening. You cant even buy something anymore without being ransacked by credit card deals. This whole world of credit is sickening. People buying lattes on credit. Im so happy the insanity is finially ending. Those who dont see it ending or will not except a lifestyle change will be the ones who will be bankrupt in 4 years.

  • JOHN - Friday, October 24, 2008, 9:48PM ET  Report Abuse

    • Overall: 1/5

    If everyone would pay their debts, we wouldn't be in this mess right now. If you can pay your mortgage, you should pay your mortgage, not walk away from your obligation because a lawyer says you can get away with it. Americans are like children who demand all the rights just none of the obligations of being adults.

  • Yahoo! Finance User - Friday, October 24, 2008, 8:41PM ET  Report Abuse

    • Overall: 4/5

    When I bought my house in 1994, my agent told me that one defense I have against over-paying is that the lender will require an appraisal and won't lend more than the house is worth. And since I was putting only 6% down, I paid PMI for about five years. If the industry had kept using those standards, this wouldn't have happened.

  • Yahoo! Finance User - Friday, October 24, 2008, 6:07PM ET  Report Abuse

    • Overall: 1/5

    There are valid reasons for letting your home foreclose - death of spouse, illness, income loss, etc. Being upside down is NOT one of them. I hope dude won't even be able to charge a loaf of bread after he defaults. I've lost the equivalent of an average home value in savings in JUST THIS MONTH ALONE. This makes me sick.

  • Yahoo! Finance User - Friday, October 24, 2008, 5:58PM ET  Report Abuse

    • Overall: 5/5

    Jack, I appreciate the difficulty you had with addressing the "upside down" issue. You gave a balanced answer to a difficult question. The world is not black and white, as many of your one-star detractors believe. I believe borrowers should fulfill their obligations, but so should banks, and they haven't exactly set a shining example of trustworthiness lately. They made stupid lending and investment decisions and they've been the first ones begging for taxpayer help now that those decisions have come home to roost.

  • Yahoo! Finance User - Friday, October 24, 2008, 4:09PM ET  Report Abuse

    • Overall: 3/5

    Instead of letting the house sit upside down taking money out of your pocket, rent it to someone and have them make your payments. Use their money instead of your own!

  • Yahoo! Finance User - Friday, October 24, 2008, 3:10PM ET  Report Abuse

    • Overall: 5/5

    Well for all those self-righeous people who say all borrowers must fulfill their contractual obligations, here's my story. Purchased a home in 2004 in Florida with 20% down. Fixed-rate, not subprime. House is now worth $100,000 less then what I owe on it. The company I worked for went out of business in 2006, I put the house on the market then, where it has languished for 2 years and 3 months. I don't have $100,000 to bring to closing to sell it at current market value. My new job doesn't pay what my old job does, and the prospects for getting a better paying one here in this economy are slim to none. I can move elsewhere to get a better job, but then I'm stuck wuth the albatross of the house in Florida to pay for PLUS living expenses elsewhere. Taxes and insurance have sky-rocketed here the last 4 years...and I have gone through my entire life savings paying for the house and taxes and insurance while it hasn't sold. I bring home $100 less then the house escrow payment per month. The smart thing would have been to stop paying for the house 2 years ago, instead of pouring more money after bad.

  • Carmine R - Friday, October 24, 2008, 2:39PM ET  Report Abuse

    • Overall: 1/5

    What the person below said about not being able to garnish wages on an unsecured debt is not true. A company can sue you for unsecured debts that you owe them. If they win, and it is likely they will, then they have the right to collect by draining your bank account, garnishing your wages, etc. They can't attach your 401k or your social security money if you have either of those. I know this to be fact, because I know someone that it happened to (credit card, not mortgage, credit card being an unsecured debt). Whether or not a company chose to sue someone for defaulting on his/her mortgage is another matter. It is unlikely that they would unless they were certain that the defendant had the ability to pay the judgement if one was awarded. However, if lots of people who are capable of paying their mortgages begin to default because they are upside down and they think they can get away with it, then more companies may start looking into this.

  • Yahoo! Finance User - Friday, October 24, 2008, 2:27PM ET  Report Abuse

    • Overall: 5/5

    Damn straight, Jack!!! A house is an investment. If that investment no longer profits you the moral obligation is first to yourself.

  • Yahoo! Finance User - Friday, October 24, 2008, 1:26PM ET  Report Abuse

    • Overall: 1/5

    You call that good information? You are helping to fuel this crisis by advising people cabable of paying to walk! You are a moron as are most of the people who are upside down on their mortgage. Most would not be able to calculate the "financial gain" from letting their house go into forclosure. America has changed, it's now socially acceptable to default on your obligations and even declare bankruptcy. People who can pay their bills should. Pehaps this will spill over into cars, I think a lot more people are upside down on car loans.

  • Yahoo! Finance User - Friday, October 24, 2008, 1:17PM ET  Report Abuse

    • Overall: 4/5

    Upside down borrowers - notice I don't say home owners, since these people own nothing but debt - should indeed walk away. Their home will never be worth what they paid. Well maybe not never but not for the next 10 years at least. By paying their mortgage they are simply throwing good money after bad. They'd be better off walking away and renting the same house for less money.

  • fallline - Friday, October 24, 2008, 1:03PM ET  Report Abuse

    • Overall: 1/5

    Shame on you for suggesting that an upside down borrower shoud walk away if is in their best interest which is a breach of contract. You are exacerbating the current "cascading" effect of the real estate depression and contributing to the decaying moral fabric in the world.

  • Yahoo! Finance User - Friday, October 24, 2008, 12:27PM ET  Report Abuse

    • Overall: 4/5

    One thought, the lender does participate in the upside. It's called interest payments. They also participated when they took an origination fee that they put inside the mortgage. Again when they sold the mortgage, again when they serviced the mortgage. Should they participate in the downside? They are. Is there less downside for all parties if they rewrite the loan and take down principle? Perhaps.

  • Mike - Friday, October 24, 2008, 10:22AM ET  Report Abuse

    • Overall: 2/5

    If you walk and there is a deficit loan balance after foreclosure, that amount is unsecured and the bank cannot garnish a borrowers wages for unsecured credit. Thats why borrowers can walk away from the debt regardless of value.

  • Yahoo! Finance User - Thursday, October 23, 2008, 9:36PM ET  Report Abuse

    • Overall: 1/5

    Depending on the laws of the state, the bank can foreclose on the house and then go after the former homeowner for the difference between what the house sold for in foreclosure and the balance of the mortgage. So the homeowner is still responsible for the $40k that he is underwater, only now he owes it as just plain old money with no house that might still appreciate some day. If he doesn't pay, the bank can go and garnish his wages. And the bank has no incentive to sell the house at the highest price. So if the original $200k house is now worth $160k, the bank might sell it for only $140k and then come after you for $60k (and for all the fees). NOT worth it, unless you are also planning to declare bankruptcy and start all over again.

  • Steve - Thursday, October 23, 2008, 8:17PM ET  Report Abuse

    • Overall: 1/5

    What have the American people become? A bunch of whiners who demand free homes, free food, free retirement, free health care, and free higher education? The demands from the free loaders far out weigh ALL the INCOME of those who WORK. I have no interest in being a slave to those who don’t think they have an obligation to work and provide for themselves and their family. So, since I own a small business, I’ll take the advice of the author and stop paying all my business bills, take all the cash out of the business and then walk away from the business debt. Sure I’ll stiff my employees out of weeks of wages and benefits, and sure I’ll stiff my suppliers, and yes I’ll screw my banks and investors. But it’s so unfair that I have to pay them back. America is doomed if this mentality infects the last half of the population that actually continues to work and live up to his or her obligations.

  • Yahoo! Finance User - Thursday, October 23, 2008, 8:07PM ET  Report Abuse

    • Overall: 1/5

    1) Looks like - this article is a tacit/direct support to "upside down" borrowers to walk away. Didn’t these borrowers make money when they sold their previous house before “moving up” ??? -------2) A LENDER LENDS MONEY, NOT a HOME. So the OBLIGATION of the BORROWER is to RETURN the MONEY - NOT the HOME back ( barring job loss or catastrophic medical issues ). It should be upto the lender to accept the home though. ----- 3) To the people who are giving such advice ( including the candidates) , if I borrow $1000 from you and buy lot of socks and underwear, use them and then dump them ALL in front of your house ( instead of returning the $1000 ) , is that OK with you ??. -------- 4) Unbelievable what sort of UNETHICAL ADVICE people give. And we blame Wall Street only. Main Street is as bad as Wall Street. Both are TWO SIDES of the SAME COIN. Made out of same material. No difference. BORROW MONEY and DONT RETURN THE MONEY if what you bought with it went down – is this the NEW MANTRA ?? – U N …. B E L I E V A B L E !!!

  • Woody - Thursday, October 23, 2008, 5:26PM ET  Report Abuse

    • Overall: 2/5

    About these "upside down" borrowers. Every single person who has purchased a car or truck with a loan was "upside down". There is no logical reason to not make your payments. Your car or truck will NEVER increase in value during the life of the loan. Your home on the other hand will most likely return to or surpass the loan value. Let's face it. You're not in business. It's your HOME. You cannot treat your home purchase as if it's a business venture. Walking away from your obligations is an act of cowardice. You should be locking the doors and making the bank chase you out at gunpoint rather than cut and run. Pay your bills period.

  • Ed - Thursday, October 23, 2008, 4:57PM ET  Report Abuse

    • Overall: 1/5

    Hey Jack, what kind of advice are you dispensing here? First, a mortgage is a contract that both the borrower and lender must fulfill. If everyone started walking away from contractual obligations, our legal system would become that of a banana republic. Second, your answer to the question regarding lenders demanding immediate payment of the entire amount is not entirely correct. If a borrower defaults on a payment or other terms of the mortgage contract, the contract generally stipulates that the entire balance becomes due. It is then up to the lender what course they want to pursue. Jack - you should not be giving advice on topics you don't understand.

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