If you have a mortgage for more than the value of your property, what do you do? If you’re the owner of Manhattan’s largest residential property, you might decide to walk away, leaving your creditors in a mess while you go about your business.
In fact, this is precisely what happened when Tishman Speyer, the American company that invests in real estate, abandoned the 11,000 units in Stuyvesant Town and Peter Cooper Village in Manhattan in 2010. It was one of the biggest failures in history – and the company has always managed to stay in business. Tishman Speyer was only following the path of many commercial real estate companies that had come before him.
However, if you have a residential mortgage, walking away from a mortgage will likely look different (it’s unlikely to be that easy or straightforward). Still, it may surprise you to hear this advice: Mathematically speaking, walking away can sometimes be the safer choice.
Key points to remember
- There are times when moving away from a residential mortgage is the best option.
- During the Great Recession, many homeowners – even those who had enough income to cover their mortgage – decided to move out after their homes fell in value.
- Some experts say it may make sense to forgo a mortgage whenever it is possible to rent similar accommodation for less than the mortgage payment.
- Variable rate mortgage holders who own homes that have lost value are more likely to abandon their mortgage during periods of rising interest rates.
- If moving away is the best option, be prepared and plan your next place to stay.
When walking away makes sense
Before the nationwide housing bubble of the late 2000s, one could generally expect house prices to rise over time. Although a few geographic areas sometimes experience declining values, on a national basis, homes have gained in value over time. Until then, this was the long-term trend in the United States
However, in 2008 and 2009, property values fell (sometimes showing double-digit declines). At the end of 2009 and the opening of 2010, about 25% of all mortgages nationwide were underwater – the amount owed on mortgages exceeded home values.At this point, what was previously unthinkable for some happened: Borrowers who could still afford to make their mortgage payments decided not to.
If you can rent a house of a similar type for less than the cost of the mortgage, some experts suggest moving away from a house is a good financial decision. In a scenario where you are underwater on your mortgage and faced with rising interest rates (due to an adjustable rate mortgage), the incentive to withdraw may be even more attractive. (When a housing crisis strikes, the big winners are often renters.)
Calculating the Cost of Forgetting a Mortgage
The calculation to compare the cost of rent to the cost of a mortgage is a simple calculation. One tool for estimating your monthly mortgage payments is a mortgage calculator. Figuring out how long it will take your home to recover its lost value is a slightly more complex endeavor. Using an annual increase in the value of 5% will provide an approximate figure based on national averages.A little research can help you make adjustments for regional and local markets. Let’s take an example:
- Original price: $ 200,000
- Value of the day: $ 150,000
- Loss of value: 25%
|Year||Starting value||+ 5%|
|1||$ 150,000||$ 157,500|
|2||$ 157,500||$ 165,375|
|3||$ 165,375||$ 173,643|
|4||$ 173,643||$ 182,325|
|5||$ 182,325||$ 191,442|
|6||$ 191,442||$ 201,014|
If the value of real estate climbs an average of 5% per year, it will take six years for that house to reach its selling price. This allows the homeowner to break even, but there is no profit to show (and the homeowner has paid interest on the loan every year). If prices fall another 10%, the recovery will take even longer. (Obviously, the appreciation of the price of housing is not assured.)
- Original price: $ 200,000
- Value after 25% decrease: $ 150,000
- Value after another 10% drop: $ 135,000
|Year||Starting value||+ 5%|
|1||$ 135,000||$ 141,750|
|2||$ 141,750||$ 148,837|
|3||$ 148,837||$ 156,279|
|4||$ 156,279||$ 164,093|
|5||$ 164,093||$ 172,297|
|6||$ 172,297||$ 180,912|
|7||$ 180,912||$ 189,958|
|8||$ 189,958||$ 199,456|
|9||$ 199,456||$ 209,429|
The payback time is now over eight years.
Mortgage exit methods
Short selling, voluntary foreclosure, and involuntary foreclosure are three of the most common methods of getting out of a mortgage. A short sale occurs when the borrower sells a property for less than the amount owed on the mortgage. The buyer of the property is a third party (not the bank), and all proceeds from the sale go to the lender. The lender either forgives the difference or obtains a judgment against the borrower. Then the borrower must make the payment of all or part of the difference between the sale price and the original value of the mortgage.
Not all lenders will accept a short sale, but if they do, short selling offers an alternative to foreclosure.
In a voluntary foreclosure, the owner voluntarily transfers the property to the lender. To arrange a voluntary foreclosure, talk to your bank and arrange to hand over the keys to the property. While this process negatively impacts the homeowner’s credit rating, additional mortgage payments are no longer required.
Involuntary foreclosure is initiated by the lender for non-payment. The lender uses the legal system to take possession of the property. While the owner is often allowed to live in the property for months (free of charge) during the foreclosure process, the lender will make an active effort to collect the debt and, in the end, the owner will be evicted.
The Standard Double
Companies regularly downsize and restructure their debt. This can hurt (and sometimes destroy) providers they don’t pay. However, these are considered “good” trade movements; the stock prices of these companies generally increase thereafter.
However, when an individual owner tries to make the same decision, the legal system is put in place to protect the profits of the lender. While only a minority of banks will accept a short sale for an owner, all are willing to foreclose.
A level playing field for consumers and businesses would mean that homeowners should feel no remorse about giving up a loan than businesses that default or have foreclosed properties. Because the ground is not level, borrowers who leave must be prepared to accept the consequences, which can include damaged credit, harassment from collection agencies, and years of difficulty obtaining credit.
The bottom line
After you’ve finished your research, if walking away is your best bet, be prepared. To make sure you have a place to stay, buy a new, smaller home – or rent an apartment – before you move out of your current home. Buy a car and other big ticket items that require financing before your credit rating goes down, and set aside money to ease the transition.
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Federal Reserve Bank of Saint-Louis. “Median Selling Price of Homes Sold in the United States”. Accessed June 29, 2020.
CoreLogic. “Perspectives on Owner Equity”. Accessed June 29, 2020.
Federal Reserve Bank of Saint-Louis. “Average 5/1 Year Adjustable Rate Mortgage in the United States”. Accessed June 29, 2020.
Basic logic. “January marks seven years of annual home price appreciation.” Accessed June 28, 2020.