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Are the Rich Walking Away From Million Dollar Mortgages?
| July 16, 2010 | Posted by Roshawn Watson under Uncategorized |
By: Roshawn Watson
Depending on where you live, a million dollars will get you a fabulous home with master suites, luxurious bathrooms, commercial kitchens, etc. With all of these bells and whistles, it would seem unlikely that anyone would want to leave. However, there’s an interesting trend suggesting that people in such homes have stopped paying their mortgages at a disproportionately higher rate than the general population. Indeed, one in seven homeowners with loans in excess of a million dollars are seriously delinquent compared to one in 12 mortgages below the million-dollar mark. Are people in these million dollar neighborhoods more broke than the general population or just more devious?
Strategic Defaults
According to Core Logic per the New York Times, “many of the well-to-do are purposely dumping their financially draining properties, just as they would any sour investment. ‘The rich are different: they are more ruthless.’” The suggestion is that the delinquent homeowners are doing strategic defaults. A strategic default is a planned mortgage default in order to minimize financial losses even though one still has the financial means to pay. Thus, these defaults are dishonorable exit strategies from unethical mortgage-holders. Often these defaulted mortgages are “underwater,” meaning that the amount owed exceeds the value of the home. Previously, I wrote how these defaults sometimes occur after borrowers have purchased second homes at lower “bargain” prices. Thus, the borrowers simply walk away from higher mortgage homes. With tighter lending standards, I presume this “buy and bail strategy” has declined, but strategic defaults are still a reality.
Not as It Seems
Core Logic and the New York Times seem to argue that the occupants of these million-dollar residences are rich. However, it is probably more accurate to say that they had or have higher incomes. The two are not necessarily interchangeable. In Good Old Middle Class or Wealthy, You Decide, I told the story of James Duran. He’s an owner of a human resource company in Silicon Valley. He bemoaned that he and his wife only make $400,000 annually, and they are “barely getting by.” They argue that although they may be in the top 2% of Americans with respect to income, they are not rich. In truth, they are probably right. Having a high income does not ensure that you will convert that income into assets and build your net worth.Of course, Mr. and Mrs. Duran have the ability to be wealthy but that doesn’t mean that they choose to be wealthy.
The truth is that the majority of homes valued at a million-plus are not owned by millionaires. According to Thomas Stanley, 72.9% of the homes valued at $1,000,000 or more are owned by non-millionaires. Think about it, it is statistically “much easier to become a millionaire if you live and consume like those in modest homes than in expensive ones.” It is also important to point out that the truly wealthy (as oppose to The Phony Rich) are less likely to be underwater because as a bunch, the truly wealthy tend to be much more conservative with their purchases. Consider that the average net worth of millionaires who live in homes valued at $1,000,000 or more is $7,000,000 or more (Wealth Works database, 2007). I seriously doubt they are struggling because the home value only represents a fraction of their overall net worth!
The distinction between high income and high net worth is relevant to the interpretation of the Core Logic and New York Times data because if you presume that the defaulters are “well-to-do” or “rich,” then it is correct to conclude that they are unethical for walking away from mortgages that they can afford. However, if they merely have or had a high income, then they are just as susceptible to the economic decline as the homeowners with lesser-value mortgages. Perhaps, they are even more vulnerable because they are so over-extended: they did stupid with zeros on the end of it.
Nothing But Speculators
Mr. Lowman is a Las Vegas agent who specializes in luxury properties is quoted by the New York Times saying of the defaulters: “they made their plans based on the best of all possible scenarios — that their incomes would continue to grow, that real estate would never drop. Not many had a plan B.” At the end of the day, I submit to you this is who we are really talking about: speculators. If you believe the popular dogma that a house is an asset, then you will be tempted to purchase as much of one as you think you can afford. You will most likely grossly handicap your ability to build wealth, but you at least will have everyone fooled into thinking that you are rich. Additionally, you may get a return on investment, but if not, you can’t be expected to pay because you are “barely making it.”
New York Times don’t confuse us with such data. Correctly call these people out for the financial fakes they really are. Don’t tell me the biggest defaulters are the rich. Sure the defaulters probably have high incomes. However, the biggest defaulters are the broke speculators who got burned trying to make a quick buck and look rich . There is a big difference.
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Thanks for telling it like it is. To be honest, I'm not all that familiar with the mechanics of a strategic default as we don't have them here in Canada. If you can't make your payments, the bank sells your house for whatever they can get and you are still on the hook for the difference. Why something like that wasn't part of finreg in the U.S. is beyond me. I won't even go into the Fannie/Freddie train wreck, but that should have been addressed years ago.
My recent post Buying a Car- Is It Wrong to Buy Foreign
Thanks for the comment @BalanceJunkie. If banks are forced to foreclosed, you are still legally liable for the mortgage debt/fees minus whatever the home brings during it sell. Since there are a lot more defaults now, it is unclear when or if banks will ever get around to suing people for these loans. By that point, people often will negotiate a settlement.
Regards,
Shawn
Shawn, It's just not right! I'm all for getting what one deserves, but this is outrageous. Barb
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Thanks Barb,
Outrageous sums it up pretty precisely. It's a sad thing when we can't trust people to meet their obligations when the going gets tough and when they have ability to do so. It is equally sad that the aspirational wealthy only care about looking wealthy instead of making solid investments.
Regards,
Shawn
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