Should I stay or should I go?

Yesterday the Huffington Post published an excellent follow-up article about strategic default: Learning To Walk: Fear, Shame And Your Underwater Mortgage. In this post the reporters followed up with 48 of the 58 families who were considering walking away from their underwater homes in January of 2010. Seems a lot of people are singing that old The Clash song, Should I stay or should I go?

If I go, there will be trouble.

Many homeowners interviewed felt a moral obligation to continue to pay their mortgage. Some drained their savings; including the raiding of their retirement accounts to keep the mortgage fed. This housing market has many homeowners trapped. In Florida 46% of the homes with mortgages are underwater – making it very difficult for people to move for better job opportunities, to upsize to accommodate a growing family, or downsize due to divorce or the empty nest.

Some of this moral commitment has faded in the face of situations that seem hopeless. Strategically defaulting (not making the payments even when you can afford to) on mortgages to force the bank to accept a short-sale is happening with increasing frequency. The article states, “Data suggest that wealthier Americans, not those with lower or mid-range incomes, have a greater proclivity for punting their mortgage obligations by embracing strategic defaults.” It goes on to list the multiple occasions where commercial entities, indeed the mortgage companies themselves, have walked away from commercial mortgage obligations.

The questions to be answered are: “When will the market recover?” and “How bad will a default damage my credit?”

When will the housing market that I am in recover?

A randomly chosen Sarasota, Florida Zillow listing clearly shows a 38% increase in market value in the short 24 months between July 2004 and July of 2006. Fifty-six months later, it has lost all that gain and then some. There are no strong signs of recovery and this home is now valued very close to its 2002 price.

Even long time homeowners who did not buy at the top have been hurt. If this home had appreciated at just the rate of inflation since 2002, it would be worth $76,000 more than its current value. People who were depending on the appreciation of their home to fund a large piece of their retirement might have to wait quite a while to recover even modest gains.

How much does a default affect your credit?

Because the FICO formula is secret, there is no way to accurately calculate the affects of different default routes. It is generally advised that a foreclosure has the most damaging affect on your score, followed by a deed in-lieu, and then a short-sale. Generally, a bank will report every month you are delinquent and each report pushes your score down – a deed in-lieu may do less damage than a foreclosure because it happens faster.

And if I stay, it will be double.

Strapping yourself to the deck of a sinking ship never makes sense. If there is a way to right the ship – DO IT! Work like crazy to get and stay caught up. But, you MUST do a honest and thorough evaluation of the situation. If you continue on the same trajectory, where will you be in 6 months – 12 months – 48 months? What do you think is going to change? Are your expectations realistic? You need find someone intelligent, who is not emotionally invested, to review the hard numbers with you.

Should I cool it or should I blow?

In the end, make a reasonable decision based on what is best for your family and quit listening to judgmental people who have neither been there nor done that.

Winners Quit

Recently I re-read Seth Godin’s book, the dip.  In this little book, Godin writes mostly to business people about knowing when to quit a project.  When he says, “Winners quit fast, quit often, and quit without guilt” it flies in the face of a lot of what we’ve been taught. Godin advises that winners quit when their path leads to a dead end – but to persevere when they are just in a dip.

This concept of winners quitting, is one that also works in realm of personal finance.

The key of course is knowing when to quit and when to stick.

For some situations, this determination is easy. If your income situation has changed for the worse, whether due to job loss, hours cut or a reduction in bonus, I have some no-fail advice for you: QUIT! Quit your old lifestyle – Today! Do not eat up savings or take on debt to maintain a lifestyle you can no longer afford.

Given the doom and gloom pessimistic economic news, it’s surprising that so many people can be so overly optimistic in their personal life. High earners are particularly susceptible to this problem. I get this and I’m also optimistic; but let’s practice a little planning for the worst. Do not let stuff drag you under; unload it and when you land that great new job you can always buy more.

For other situations, the determination is much harder. Here in Florida in early 2011, 46% of homeowners with mortgages have negative equity. Wow! That needs to be said again. Almost half of the people in Florida who owe money on their home, owe more than they could sell the home for.

If you are one of these families, how long do you stick?

People often need to move when they graduate, retire, marry, divorce, get a new job, have children, children move away, or for a myriad of other reasons. At one time as many as 20% of all Americans moved in any given year. Today, the poor housing and poor job markets have been a factor in greatly reducing that number.

Faced with either a legitimate need to relocate or the inability to realistically make the payments, many people choose to stick in their negative equity home way past the time they should have quit.

While I would not advise anyone to default on their mortgage just because the home value has dropped, I also would not advise someone to indefinitely postpone a needed move just because their home is underwater. (The “How you quit a negative equity home” is very important, but not the subject of this post).

In much the same manner as Godin advises business people to figure out if the path they are on is a dip, a cliff, or a cul-de-sec; if you feel stuck in a financial situation you need to calmly and strategically do the same.

Decide in advance when to quit.

The underwater homeowner who can no longer reasonably pay the mortgage may decide to commit “x” number of dollars of their savings toward keeping the mortgage paid while trying to land a better job or short sale the house. When the money is spent, it’s time to quit. Deciding in advance takes the emotion out of decision day and helps prevent quitting in a panic.

Will quitting now allow you to win later?

If a better job, life or family situation is on the other side of quitting, you may need to quit sooner than later. Carefully weigh the cost of sticking – waiting on the market to recover vs. quitting and starting new in a better place. The unknowns of the marketplace make this calculation very difficult but we do know that while you can make more money you cannot make more time.

Recognize the cliff

Be brutally honest with yourself. Put your what-if analysis on paper. Quantify it. Review it with someone you trust. If the path you are on leads to a financial cliff, its way past time to quit.

Remember, there is no prize for not quitting. People will not cheer your dogged determination if the end result is failure.