Buy and Bail
A colleague of mine recently received this email:
My wife and I are thinking about doing a “buy and bail.” We can’t justify paying a $440,000 mortgage when our house is now worth only $240,000. We have found some homes in our neighborhood selling for $200,000, and we’d like to walk away from our current home and get into something more affordable. We aren’t worried about our credit (our credit reports are both spotless). Forget all the moral issues: what are the ramifications to this?
These are the ramifications:
1. First and foremost, the moral issues cannot be put aside. A fully capable couple merely feels inconvenienced to honor its legal and moral obligations. The couple doesn’t feel like paying. Unlike a predatory lending situation in which the couple did not understand what it was signing, this couple is engaging in predatory borrowing.
This couple has a “heads-I-win-tails-you-lose” mentality. The couple seems to have signed its loan documents with this in mind: If our investment is good in the first few years, we will pay our obligations, but if not, we will walk away.
What if people who bought stock using their credit cards were required to pay their bill only if the stocks went up in the first few years? Obviously, this would be unacceptable. The credit card company is merely acting as a facilitator between the borrower (stock buyer) and seller (stock). Why should it suffer losses because of the borrower’s investment choices?
Yet when it comes to home loans, this attitude has become socially and politically acceptable, as though banks that fully disclosed their terms on government-mandated forms were at fault when, in fact, they were merely acting as facilitators.
2. When borrowers do not honor their commitment, taxpayers pay part of the borrowers’ bill. In an effort to keep operating at a profit and serving their customers, lenders are forced to recover their losses somewhere or close their doors. In this case, as in most cases, the losses affect hardworking and honest taxpayers in the form of higher interest rates and fees.
3. Because of people like this, Freddie Mac, Fannie Mae, and private mortgage companies have tightened the requirements for borrowers who want subsequent mortgages for homes in the neighborhood in which they currently live. To be approved for a subsequent mortgage in the same neighborhood, a borrower needs a larger downpayment and at least 25 percent equity in the first old home. As well, the borrower has to qualify for the second home without using any rental income on either home. This means fewer transitions, which further depress values for deserving people.
4. This sort of behavior not only hurts the economy, but it also hurts the country’s psychology by promulgating a society in which integrity and honor are options of convenience and neither expected nor required.
5. The borrowers’ children, who watch their parents walk away from their responsibilities, will never learn financial responsibility or integrity.
6. Fortunately, there is some justice in this. Though the couple might think its spotless credit will be affected only minimally, it might want to think again Aside from a bankruptcy, a foreclosure is the single worst thing that can happen to a person’s credit score. Husband and wife might have spotless credit now, but after a buy and bail, their credit scores will be much lower than necessary to receive the best interest rates on subsequent loans or credit cards. If they plan on buying anything with credit in the next seven years, their payments will be higher due to the foreclosure. According to a report by William Hillestad, founder of Everyday Wealth, a weak credit score costs an average of $287,000 over a lifetime. And Philip X. Tirone, author of 7 Steps to a 720 Credit Score, says a poor credit score can cost a person $212,040 in extra interest payments over the life of a 30-year, fixed-rate loan.
Paul Wylie
Please visit http://www.paulwylie.com