Some homeowners are washing their hands of mortgage debt. They simply mail their house keys to the bank, and let the lender worry about how to create tangible assets from properties that have no actual equity.

If you lend money without securing the loan with collateral in the form of bankable equity, you run the risk of not collecting your debt. That's exactly what's happening in the lending industry. Mortgage companies, however, have nobody to blame but themselves.

Home equity abuse

In recent years, many homeowners were steered, or even pressured, into loans that they couldn't afford, lured by down payments involving little or no cash. Starting with no equity accelerates the path to foreclosure when prices drop; and prices have dropped so steeply, that the lows are setting new records almost every time the data is updated. Now, some homeowners are walking away from mortgages because they have no equity to lose, and lenders have little or no leverage to discourage the practice.

Economists, for example, are citing evidence of mortgage holder mutiny as a factor in the widening loan sector crisis. As was sometimes the case during the real estate downturn in the late 1980s, some homeowners have adopted a strategy of creative debt management that involves walking away from red ink without a second thought. Rather than pay off their mortgages, they incur a severe bruise on their credit, and leave mortgage lenders holding the bag. The problem for lenders is that the bag is empty, because it never held any substantial equity in the first place.

No way out

Known as "willful default," the practice of renouncing payback responsibility in favor of a walkout often happens when consumers feel that they have no other way to salvage their credit, and have nothing left to lose. Home values are plummeting, erasing the equity of millions of homeowners who suddenly owe more on their mortgages than their homes are worth. This condition of negative equity leads to feelings of resentment and frustration. Consumers may feel that it's unfair for them to owe money on a loan that's worth more than their property. Not willing to give lenders an unearned profit, they simply walk away, letting the lender pick up the pieces and take the loss.

The price of home equity irresponsibility

There's always a price to pay for having a foreclosure on your record. With a paltry credit score, homeowners who've walked away from obligations will likely have trouble starting anew. Then again, every market operates on the law of supply and demand. If millions of consumers enter foreclosure, lenders will have nobody left with good credit to recruit as a customer base. Eventually, lenders will be forced to ease their standards, as the threat of having a foreclosure in one's background loses its teeth and clout. With tens of billions of dollars in losses, lenders are already feeling somewhat powerless.

Published on June 26, 2006