Yes, It's OK to Pay Your Credit Cards and Let Your Mortgage Go

I got some kickback after writing about debtors who, pressed for money, decide to pay their credit cards and let their mortgages go. Readers thought that was shocking, immoral, and stupid. People should save their homes at all costs, not to mention repay the debts they owe.

I used to think that way too but I don't anymore. In the long aftermath of the Great Recession and the real estate bust, the old rules are blurring at the edges.

Take a homeowner who lost a job and can't find a new one. Nearly half of today's unemployed have been looking for work for six months or more. That's the highest percentage of long-term jobless this country has seen in the past 40 years.

The displaced include people without special skills, people with the wrong skills (for example, office secretaries -- gone the way of the dodo), and many people 50 and older whom companies simply don't want, regardless of skills. They can't search for a job in another town because they can't sell their homes for enough to repay their mortgage loan.

What should they do?

Their homes are probably already toast. They might be behind on the loan and with no prospect of a modification they can afford.

If they stop paying the mortgage and use that money to clean up their credit cards, they have a shot at getting their lives back together. They might be able to stay in their homes for a year for more before the bank puts them out. After that, they can find a rental and get on with their lives.

They're also free to move to another city where they might find work. Credit cards are essential for business travel. People who move might also need a card in good standing to rent an apartment and open a new bank account.

If they default on their credit cards and also lose their home. they have no flexibility left. The same is true if they sacrifice everything for a house they no longer can afford. Of all the bitter choices faced by someone in this position, quitting the mortgage is the least worst.

What about people who walk away from a mortgage that they actually could afford to pay? The house is worth so much less than the loan against it that making payments feels like throwing money down a rat hole. It could be a decade or more before they actually have equity again. In the meantime, they're effectively renting the place, and at a much higher rent than they'd pay if they moved somewhere else.

Defaulting might make a lot of sense, financially. But a moral question rears its head. You signed the loan. You owe the money. Will you roast in hell if you don't pay it off?

I got an interesting answer from Jack Reed, author of many sensible books about real estate investing. He draws a distinction between a "recourse" loan and a "non-recourse loan."

With a recourse loan, you promised to repay the full amount. If you can afford it, you're ethically obliged to do so. Legally, you're also required to pay. If you walk away from the house and it sells for less than the money owed, the lender can come after you for the remaining amount plus fees and legal expenses.

With a non-recourse loan, by contrast, you never promised to pay in full. The contract says that you either repay or give the house to the lender for whatever it's worth at the time. Because you have this choice, the lender charges a higher interest rate.

If you want to move on and don't take advantage of the walk-away option you paid for, "you're an idiot," Jack so sweetly says. There's nothing dishonorable in abandoning a non-recourse loan.

Lenders normally don't give non-recourse loans voluntarily. Many states, however, require them for first mortgages (I found two lists of states, here and here, but they're different, so check to see what your own state says).

In any state, however, refinanced and home equity loans are generally recourse. Morally, you're stuck with repaying them.

I see two moral outs. One is deception on the part of the lender (true deception -- not that you simply didn't pay attention to what you were signing).

The other is the moral duty to your family. If you're losing your job and can find one only in another city or state, and can't sell your house, your duty as a provider ranks higher than your duty to the bank.

The bank might come after you for the money. I'll write about that next time.

More on MoneyWatch:
More Consumers Pay Off Their Credit Cards and Let Their Mortgages Go
Strategic Defaults Increasing as Consumers Choose Not to Pay Their Mortgage
Mortgage Default: What Would You Tell the Kids?