Stategic default on mortgage--non-recourse states?

[Jaketucson]

Hi, has anyone had any experience with a strategic default in a non-recourse state?  I found one thread that discussed a similar situation in Michigan, but they are a recourse state.  I'm in Arizona.  We're currently in the process of closing on a 2nd house that will become our primary residence.  We want a little more space and an extra bedroom now that our kids are getting older (1 boy and 1 girl, 5 and 2, currently sharing the same room in our townhouse).  Understanding that owning a home is not necessarily the best "investment," we've still decided to buy for other non-financial reasons (and the fact that this new house is one of the lower-valued homes in a high-value neighborhood at the bottom of the real estate market appeals to us). 

Anyway...what to do about the townhouse we currently live in?  At worst-case we're probably $40k underwater, better case $20k underwater, best case: the market is starting to pick up here in Tucson and there's a real slight possibility we could break even or only be out a few thousand bucks.  But that is almost definitely over-optimistic right now.  If we turn it into a rental, we'll most likely be losing $300/month.  Our total housing cost for this townhome is $1325 including PITI & HOA.   Rents on similar units in the 'hood are around $950-$1100.  We bought at the peak thinking we needed to get our foot in the door...lesson learned.  We refi'd in 2011 under HARP to get 5.75% and now are not eligible for further refi now that rates are lower.  Most likely scenario will be to try to short sell and take the credit hit.  We have excellent credit now so 2-3 years of a lower rating won't hurt us.  We have no plans to take on any debt (all we have is student loan and mortgage, and we'll close on the 2nd house before we deal with dumping the first).  Arizona being non-recourse, all we have to deal with is the hit to the credit report in either a short-sell or foreclosure scenario.  But I'd prefer not to foreclose.  Have read the book "Underwater Home" by Brent White which gives what seems to be sound, logical advice for people in these situations, namely that sometimes short sale or strategic default is a good financial move in a non-recourse state and to not be tied up in the fear/emotional aspect that society throws at people who default on loans.  I hate that we're in this underwater situation as we are financially responsible, live within our means and generally live a semi-Mustachian lifestyle.  Even at the peak, we didn't buy too much house and are now hurting.  We actually bought too little house with no room to grow into (1st child was only a baby).  I'm hoping the Mustachians have some good advice/thoughts about this scenario in general and mine in particular.  Happy to provide any additional financial data deemed pertinent to the discussion.  Thanks!  Sorry for the long post!

[Saving mom]

Don't do it. Rent it out and eat the loss until prices return. Frankly buying the bigger house and putting yourself in the position of owning two houses is very in-mustachian.

[Jaketucson]

Hi Saving Mom,
I appreciate the frank response.  And I do realize that this scenario is a pretty glaring example of un-mustachian behavior.  I do need to clarify my original post--we have an offer on the 2nd house which is a short-sale and we're waiting for the bank to accept the offer.  Closing is not imminent, didn't mean to imply that.  We're at a point where we can easily walk away from this 2nd house and remain status quo.

It was never our intent to own two houses, but the traditional model of buy while selling current home obviously won't work here (unless there's something I'm not thinking of).

Here's the thing:  The fact that you can short-sell or walk away from a mortgage in Arizona with no repercussions other than credit hit makes buying a new house in this market and dumping our current one (either by short sale or default) an appealing path, and strangely it seems a good long-term financial move since the credit damage won't really affect us.  The house we're looking at is a short sale, and property values in the neighborhood are about $25-45k higher than our offer.  I'm frankly surprised the bank hasn't countered yet, but that could still be coming.  We'd be staying in this house very long term (10-20 years is the plan).  The house appears to be structurally sound, all systems new-ish, but we're ready to walk away if something huge comes out of the inspection.  Our current house has no yard, very little room to entertain friends, no room to garden, etc.  We're not out grabbing for a McMansion by any means.  The houses we've been looking at are only about 300 sq ft larger than our current house but are much more functional for the kind of lifestyle we want to lead, which actually does fall more into mustachianism than not.  Our commutes which are small already would barely change.  In fact, it's been exasperating trying to explain to family and friends why we don't want a huge house farther away from where we both work. 

Our original plan was to get into a house that fits us better, then aggressively tackle my wife's student loan ($37k, both the student loan and current mortgage are 5.75%) in 3 years or so, then start getting into the investing side of things.  We're both in work pensions/401k plans so are building a 'stache but want to start getting more aggressive with that once the student loan is paid off.  Mortgage rates are so low right now that aggressively paying off the new mortgage isn't a priority if we go that route.

I apologize for the verbal diarrhea.  I'm trying to show that we've really thought about this and we're not just grubbing for more/bigger/better.  I really do appreciate all the wisdom being shared in the forum, and I don't ask these questions lightly.  I've been wrestling with this scenario and running numbers, and this truly does seem like a good move to make.  Has anybody here been through this or wrestled with a similar decision? 

[grantmeaname]

I wouldn't feel morally comfortable walking away from the house even if I lived in a non-recourse state. That's one dimension of strategic foreclosure that you haven't really mentioned in your post at all. Is it something you feel comfortable with?

[Jaketucson]

Yeah, I guess that was unsaid but the moral issue is one of the reasons why I'm seeking advice here (and from many other people as well).  I'm glad you brought it up specifically.  One question--from a moral standpoint, is going through a short-sale seen as equally "immoral" as just walking away?  To me, it doesn't seem like it but I have no previous experience with this.  But it's why we would first try the short-sale route.  Being someone who has always seen my commitments through (financial or otherwise), the strategic foreclosure route does scare me.  The book I mentioned in the original post has several examples where banks or other commercial entities default on properties when the financial data no longer work in their favor, and no one judges that as immoral, just the process of doing business.   This is a double standard when it comes to individuals and their homes.  Someone's borrowing the book right now otherwise I'd use exact quotes.  On a certain level a mortgage is just like any contract, with consequences when the contract is broken.  It seems that for us, we can weather those consequences.  So is this truly just a "business" decision?  What else should I be considering?  Property values in my area are already crap.  I plan on continuing HOA payments until the short sale is complete or until foreclosure happens.  To be fair, the gist of that book is that if you are truly in dire straits (lost job, true inability to pay, etc) then you shouldn't deplete all your savings/retirement stash to stay in a mortgage that you can't afford.  We're not in a worst-case scenario like that which does sway me to the "morally this may not be the right thing to do" side.  There's definitely that element of "a lot of other people are doing this, so why shouldn't we?" going on and frankly I'm torn about the morality of it.  I understand that just because others are doing it doesn't make it moral.  The numbers are saying "yes," the moral gray area is making me hesitate.  I see it as a gray area.  I understand many will see this as black-and-white and I appreciate hearing those viewpoints as well.

[lakeridge]

I understand your dillema.  We will be going through the situation you describe shortly.  We lived in AZ for 5 years and when we left for job transfer in 2009 rented out our house.  Now our tenants are leaving and we are tired of making up a large shortfall every month and property is so far underwater that it would probably take 10 years to get back to even.  Sounds like you know what the right financial decision is based on calculations- you just need to be able to live with or reconcile yourself with taking this action.  Lenders are seeming to be a bit more cooperative in short sale situations and Arizona has a fairly tight housing supply now so a short sale may be able to happen within a few months.  I happen to agree with your analysis that this is a business decision and walking away will not cause me to lose any sleep, but that is a very personal decision that many others will disagree with and tell you that it is "morally" wrong and irresponsible.  Don't let others guilt you into sticking with a bad situation.  If you're ok with it and you feel its the best for your family and your situation- that should be it.  Definitely try the short sale first as lender will be more willing to work with you. However- the numbers don't seem that bad- 300/ month loss is not huge and 20-40k underwater has a chance of coming back in a few years.  If you factor in tax deduction/depreciation on rental property you may not be out too much.  In my case- I'm well over 100k underwater and tired of losing 500+ per month for the last 2 years.  Good luck.

[Portland Man]

What is "immoral" about it?

You've got a contract that spells out the consequences of breaking said contract, so long as you are willing to accept those consequences, walk.


At least, that's how it should work.  With the huge number of foreclosures out there I guess there is an argument that you are acting immorally with respect to other homeowners in the area, by allowing your house to be foreclosed you decrease their property value.

I'd say walk if it pencils out, and try not to do it again.

[arebelspy]

What is "immoral" about it?

You've got a contract that spells out the consequences of breaking said contract, so long as you are willing to accept those consequences, walk.

That's one point of view.

The other says that you agreed to a contract, and you should try to live up to your agreement.  The consequences are for if you can't, not if you choose not to, because you should choose to honor your word if you have the ability to.

I won't say which I tend towards, but wanted to at least present the other side.

FWIW, I will add that a short sale (cooperating with the bank) seems at least slightly more ethical than just walking away and vastly moreso than just stopping paying, living free until they evict you.