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Should You Walk Away from Your Mortgage?

by Contributor

There are many homeowners who have found themselves in the unfortunate position of being underwater on their home. Some of these homeowners live in a neighborhood where home values have declined, and others took out too much in home equity loans. In some cases both happened.

While it’s understandable that these homeowners are frustrated, some have decided to simply walk away from their homes, even though they can afford to make their monthly mortgage payments. This is known as strategic default. There are numerous problems with the decision to walk away from one’s home when the borrower has the ability to pay.

Is walking away from your mortgage moral?

First, there is a moral aspect to the decision. You signed a contract and agreed to pay a monthly price for your home. Unless the contract had a stipulation that you can walk if your home’s value falls – and I’m not aware of a single mortgage contract like that – you are not fulfilling your obligation. Some will argue that it’s a business decision, but I think it’s more than that. After all, would a homeowner whose home appreciated in value call it a “business decision” if the bank decided to increase their mortgage payment as the home’s value rose? I seriously doubt it.

I believe we are all obligated to honor our contracts unless there are extenuating circumstances which prevent us from doing so.

I want to be very clear that when I talk about the moral aspects of walking away from a home, I’m talking about people who can afford their payments. I know first-hand that there are people out there who really cannot afford to make their payments and want desperately to stay in their homes. Those people may not have a choice when it comes to giving up their home.

Who does walking away hurt?

In essence, walking away hurts the homeowner who is walking and every other homeowner out there. As homes are sold as short sales or foreclosures, the values of neighboring properties decline. If homeowners walk away from homes they can afford, it just perpetuates the cycle. The only way neighborhoods are going to recover is for homeowners to hang in there and watch out for one another.

I’m a fairly optimistic person, and I truly believe the tides will change and properties will eventually regain their values. Those who think they’ve lost the equity in their home forever are really creating a self-fulfilling prophecy by contributing to declining property values and adding to the amount of foreclosures and short sale homes that are sitting on the market.

I’ll just rent after I walk

Homeowners who think that they can walk away from their homes, rent for a bit and start over are going to be in for a big surprise.

When someone lets their home go into foreclosure, it harms their credit score and leaves a black mark on their credit report. It’s a black mark that will stay on their credit report for seven years. Many landlords do credit checks on their potential renters. Seeing a foreclosure is likely going to be a red flag to the landlord that you’re not capable, or willing, to make your rent payments on time.

The foreclosure is also going to be a red flag to lenders if the homeowner would like to buy a home or take out any new credit in the next seven years. In addition to the decision of whether or not to give a potential homeowner a mortgage, lenders also base interest rates on the borrower’s credit score. The borrowers with the best credit scores get the best mortgage terms and/or interest rates. A foreclosure is going to put the borrower in a bad position when it comes to getting credit … if they can get credit.

Allowing a home to go into foreclosure clearly isn’t something that should be taken lightly or decided quickly, especially if the homeowner can afford the monthly payments. I would urge people to consider all of the long-term effects of a foreclosure, including their plans for the next seven years, before making a final decision.

Kristen Doerschner is the public relations coordinator for a non-profit debt relief agency and a freelance writer. Through her writing, Kristen covers a variety of topics, but specializes in issues related to financial education.


Published or updated August 3, 2011.
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{ 56 comments… read them below or add one }

1 Victorino

I totally agree. Walking away from your mortgage is a dishonor to the contract you have signed. It’s a universal law…honor your neighbors. If we dishonor our mortgagee (creditor), we know there will be a big drawback in our credit score, and also in our reputation.

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2 nfinity

What morals? There is no honor in a contract. It’s business. Obviously this scaremongering tactic about heavens falling if you leave your house is garbage. Everyone who’s screwed over should leave their house. Banks got their bailout money, we all got screwed and now we are left to our morals to pay for something that wasn’t our fault.

I’m dumping my house faster than you can spell bailout. And short-selling a home is much better. I’m sickened by articles like this. This country and corporations and wall street did nothing for me and I had the best intentions when I bought the house. There is no emotional connection here. I REFUSE to get screwed over and over again and nobody should.

I am a hard working person who bought a home to live in and kept paying everything on time. What did i get in return. Those responsible got the bailout and I was stuck with $200k over the price of what I paid that I will never be able to get back. Anyone saying that I should keep paying is nuts. You just keep on sucking that lolipop that banks and government sell you and the “moral” responsibility they are preaching.

Nobody had morals from those responsible for this including banks and government and neither should you.

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3 fredct

nfinity, are you in a non-recourse state? Otherwise be aware that the bank has every right to come after you for the additional $200K you borrowed that you didn’t pay back. Even if they forgive it, you’ll still need to recognize it as income and owe anywhere from $20K to $80K on it, depending on your tax bracket.

And I’m sorry, but of all the argument on this thread, the least convincing is your ‘poor me’ argument of being ‘stuck’ with a house worth $200K less than when you bought it. You made a mistake sir – what happened to personal responsibility? You paid way more for a house than you probably should have. Those of us who weren’t drinking the NAR’s coolaid had known for years that housing prices were ridiculous.

You could have saved a ton of monthly cash flow (nevermind the value loss) by sitting on the sidelines and renting. And no, you didn’t *need* to rent an apartment – if you wanted to live in a house, you probably could have rented a house for a fraction of the mortgage cost (big sign that housing prices are way out of wack).

No one held a gun to your head, no one forced you to buy your home at ludicrous, unsustainable prices. No one forced you to contribute to the bubble. But you did. *You* made a mistake. Any now, pity you… *you’re* being screwed over? I’m not buying it.

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4 nfinity

QUOTE: And I’m sorry, but of all the argument on this thread, the least convincing is your ‘poor me’ argument of being ’stuck’ with a house worth $200K less than when you bought it. You made a mistake sir – what happened to personal responsibility? ENDQUOTE

I’m sorry fredct, but I didn’t make a mistake. . The reason why my house is worth what it’s worth is because of the mismanaged regulations and bank greed, not some market conditions or me buying a bad house. We have to separate the two. If I made a bad investment and bought a property that got me into a dumper I would probably not be agreeing with bailing out in such a way. But this has nothing to do with that. We are here because regulations and greed caused it and if the ones responsible had no moral obligation and operated on a different set of rules so can people who want to leave the house.

You are correct, I’m in AZ which has an anti-deficiency law and I’m fortunate because in other states people will not be so lucky so foreclosure is the only option. But either way you look at it, it’s better to even deal with consequences of foreclosure than to be a slave to a property due to things that were out of your hands and have $200k or more owed on the house that’s worth nothing.

The situation here will not change in the next 10-15 years. At least next 7 years we won’t see a significant increase in home prices and even after that the price people paid for houses they wanted out of best intentions will never be reached.

The reasoning that people shouldn’t have bought the houses is kind of ridiculous. You buy a house because you want to settle down and the general rule was that if you have a good house in a good location you wouldn’t lose money. House was treated as an appreciation asset. So people bought. You couldn’t also affect the prices because for anyone who wanted a house bought it at the market value and it was based on value of other homes in that specific neighborhood.

Are you really saying that all of the people who bought houses should’ve known that the collapse will happen and should’ve rented? Then why don’t we all just rent and nobody should own a house. Because that’s what you are saying.

And don’t sell me the whole you bought a house you should stick with it for 30 years. It’s not simple like that. You might want to move to another city, you might want to buy a different house after 10 years etc etc.. Nobody should be a slave to something that was not their fault, sorry and for a lot of people this situation we are in was not our fault. We paid and played by the rules while gov’t and lenders didn’t and that’s why we are here.

5 TC

Here’s the case where fredct and I are pretty much in agreement.

nfinity, you are stuck with the contract you signed, and an appeal to “Well they got a bailout!” isn’t helpful. Most banks are not getting bailed out – they get shut down by regulators and the investors lose. Only the biggest banks got bailed out, and that was to avoid systemic failure, not out of any moral obligation.

(Indeed “moral hazard” – an economic term – was more created than avoided by these bailouts. I have a view about the politics of this, but it’s not germane to this discussion.)

All of the comments I’ve previously made about the bank valuing an asset incorrectly apply to buyers as well. Banks and buyers both have the same responsibility to analyze the market. In my experience, too many buyers don’t behave rationally in this are as well. Particularly in recourse states, there can be very serious consequences, very close to the consequences of bankruptcy.

The one place nfinity and I agree is that a short sale is a reasonable way to get out. A short sale requires lender agreement, so it’s a joint modification of the contract. Lenders make an economic decision that benefits them, and will also benefit the borrower by removing the debt and limiting the credit damage. Banks don’t like short sales, because they have to realize the loss immediately, rather than hanging onto an overvalued asset in the hope that prices will recover. Neighbors don’t like short sales because they suggest assets were overpriced, and the value of similar assets falls. Short sales are good, though, because the market is finding real values, and new buyers are getting a fairly priced asset.

A short sale is a much better solution, all around, than strategic default, if both sides are willing to negotiate.

tc>

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6 fredct

Glad to hear we mostly agree on my main point there, TC.

For the record, I have no issue with short sales. A short sale is a mutually agreed upon solution between both parties on a contract (an agreed-upon modification to the contract you could say), and is completely appropriate.

7 Charp

I don’t think it is a moral obligation to stick it out. The bank took the risk to loan the money, with a lot more knowledge about the housing market than the average consumer. But my biggest argument is that the bank has still made money from my loan. All of the interest that I have paid to date more that covers the amount underwater that the back would out if I was to default.

8 Darrel Fletcher

I agree with you 100%. If the banks are not willing to negotiate, then it is time to get out. If not, you will be throwing good money away.

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9 David Hall

Finally some truth here. Not only did the financial industry make out mike bandits, congress, has never stood up and accepted responsibility for putting Americans in this situation. Barney Frank and the rest of his incompetent friends just plain put it to us. Now all we hear is spin.

Well written nfinity!

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10 keith

The contract I signed states I pay a monthly payment or they take my house. Contract honored. Get over yourselves.

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11 fredct

I agree with everything that’s been said – yes, its a moral issue & yes, it’ll slam your credit – but I think you’ve missed an even bigger point.

Many people are willing to take the credit & moral “hit” thinking that it will erase their debt… but it does not! If you foreclose and the bank sells for less than you owe, they can still come after you for the difference. You still owe it.

And if you *do* make an agreement with them to forgive any portion of the difference, the forgiven money is taxable and reported on a 1099-C (which means you’ll end up owing 10-50% of the forgiven amount to the government in taxes).

Before even considering such a move, people should be aware that it doesn’t eliminate their responsibility anyway.

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12 Bible Money Matters

I can’t even imagine walking away from a contract that I signed knowing full well what the consequences were. I think it is a moral issue, one of keeping your word, despite it not being pleasant.

We had a woman that lives down the street from us walk away from her house recently even though she had the money to pay allegedly, just because she didn’t like being 20k underwater in her mortgage. Her foreclosure and others in our neighborhood really hurt our home value quite a bit, and we were none to happy with her, or our other neighbors who just walked away. Personally i just don’t get the mindset that says doing this is OK.

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13 TC

I disagree entirely about the morality of walking away. Your decision should be driven by the economic consequences of abrogating your contract. If you live in a non-recourse state, the bank knew that when it made the contract with you. If you live in a recourse state, be aware that the economic effects may include the bank coming after other assets.

Ignored in this analysis (and in most people’s analysis) of walking away is that when you walk away, the bank gets the house. The economic risk associated with the mortgage was always balanced by the bank’s ability to take ownership of the asset. If they incorrectly valued the asset, you have no moral obligation to cover that loss for them.

You should honor the terms of a contract when it makes economic sense to do so. If you decide to leave a wireless phone contract early, you should pay the termination fee with a clear conscience and walk away. You have no obligation to keep using a service that is not valuable to you. Similarly, if your analysis of the economic effects (including the effect on credit scores and future interest rates) shows a house is no longer valuable to you, you should avoid a decision based on emotion.

(I have no plans to walk away; my home has lost a third of its value, but is still worth what it costs me.)

tc>

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14 fredct

The big difference with the cell phone example, is that paying the ETF in order to walk away is part of the agreed-to contract. There is no such agreed-to ability to walk away from a mortgage contract. Walking away from a mortgage is violating the terms … paying an ETF to cancel cell service is following the terms.

Walking away from the mortgage is more equivalent to refusing to pay the ETF and also refusing to pay for service.

I am greatly disturbed by your suggestion that you should only honor your written agreements when its in your best interest to do so.

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15 Kristen

@fredct, good point about the taxes. As far as whether the homeowner will owe the difference, it depends. I believe people who live in a non-recourse state do not have to pay the difference. Any lawyers out there know about this? Some lenders go after the difference in a foreclosure or short sale, but not all. It’s definitely something for people to research and seri0usly consider when comtemplating walking away.

@ Bible Money Matters, your anecdote of the neighbor who walked is exactly what I was trying to get at when I said a foreclosure hurts everyone. Unfortunately, I don’t think many homeowners who have the ability to pay and still walk really care about their neighbors.

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16 Kristen

@TC, I was waiting for the comments like this to start. First, to address your point of “the bank gets the house.” Yes, but that is not a win for the bank. Foreclosures cost the lender money. The bank doesn’t want your house.

When you sign a contract, you are not guaranteed that your h0me will retain or increase its value, so you also agree to take an economic risk when you sign your mortgage papers. Why do you think its okay to leave your mortgage lender holding the bag and walk away with no further obligations (if you live in a non-recourse state)? If your house had gained value, would you be okay with the bank making the economic decision to increase your mortgage? If you lent a friend or relative $1,000 and they decided it didn’t make economic sense for them to pay you back, would you be okay with them simply not paying you and saying, “Too bad. This is what’s best for me?”

I just really feel like some people have a real sense of entitlement and lack of responsibility, and I find it frustrating. We’re going to see much worse problems if everyone decides they don’t have to pay back their debts.

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17 Troy

Unfortunately TC is exactly right. Your rebuttals, while honorable, are misguided.

There are two parts to a mortgage. Pay or don’t pay. Those are the only two options and each is spelled out in great detail on a deed of trust. Not paying a mortgage loan is not breaking the contract, it simply begins enforcement of the second part. I hope you understand this.

Contract states pay OR we take the home back. Key word is OR. So either way both parties are fulfilling their contractual obligation.

You talk about morality. Walking away and giving the house back is not immoral. Not paying and being able to keep the house is immoral. OR, paying your payemnt on time and the lender still having the ability to foreclose is immoral. Because those items are not contractually agreed on.

And walking form a mortgage is EXACTLY like early termination of a cell contract. Terminate the contract (Walk) and here are the penalties. The penalties are spelled out at the onset of the agreement.

A deed of trust has several pages of default remedies spelling out exactly what happens and how upon default. And that defalut is calculated into the interest rate.

That is what an interst rate is. It is a risk premium. Risk of what. Take a guess…default. Every bank on the planet that has charges interest on a home loan understand the risk of default and had been compensated accordingly.

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18 ctreit

As TC said, if you live in a recourse state, the bank may come after your other assets to cover its losses if you walk away from the mortgage. That is something that is often overlooked in this discussion. There are tremendous economic consequences to walking away from your mortgage that also affect your ability to rent, for example.

Nevertheless, I cannot follow the moral argument for one major reason. A mortgage contract is signed by two parties: the one who takes the mortgage, the individual, and the one who gives out the mortgage, the bank. How moral do you think the bank would be, if an individual runs into unforeseen, severe troubles but if that individual is doing “the right thing” otherwise? A contract has legal consequences for either party, but no moral consequences at all. That is how the bank looks at it and so it should. Why should the individual act differently?

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19 fredct

“How moral do you think the bank would be, if an individual runs into unforeseen, severe troubles but if that individual is doing “the right thing” otherwise?”

But you’re not making a valid comparison. You’re asking here about the bank here to go above and beyond their contractual responsibility and make special exceptions for people. (Although it’s great if it did, that’s simply not a fair comparison in this discussion)

No one’s saying the buyer so go above and beyond and work for the bank for free to defray, or offering to voluntarily offering to garnish their wages indefinitely until its paid off.

The discussion is merely saying that you should live up to your agreed-to, signed-up, contractual agreements, just as the bank does.

For example… chances are in your savings somewhere you own some corporate bonds. Bonds are a loan to a company or government that they agree to pay back on certain terms. Would it be okay with you if that entity decided it was no longer in their best interest to pay those bonds? Not that they couldn’t (that’s a risk that you sign up for as a lender) – just that they no longer wished to and have decided its better for them not to? And so several thousand dollars of your savings just disappeared? *Thats* the equivalent to what you’re suggesting individuals do.

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20 ctreit

Sorry that I did not make myself clear. I do not expect the bank to go beyond what was agreed on in the contract. Both parties have a legal obligation to hold up their end of the bargain. There is no question about that. I am only saying that neither party has a moral obligation. Walking away is not part of the contract but like a default of a corporate bond, the “walking away risk” is real. Both parties understand that. Sometimes companies and even countries default on their bonds because it benefits them financially. Nobody is asking companies or countries to do the right thing “morally speaking”. Default is just part oft he game. That is why we paying an interest rate is part of the contract.

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21 TC

@fredct I find the notion that I have responsibilities beyond the terms of the contract disturbing.

My mortgage has more than a page on what the bank’s remedies are if I don’t pay the agreed amount, or if I fail to maintain the property, or even if I’m sued by a homeowner’s association or government entity. Clearly the bank contemplated what would happen if I didn’t pay, and prescribes penalties and conditions under which they can take possession of my house.

I don’t think the bank has any moral obligations beyond the letter of the contract, including the circumstances under which the agreement can be terminated. I don’t think I do, either.

tc>

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22 fredct

I don’t have your mortgage contract in front of me, but there’s a difference between a “how to get out of this contract” page and a “what happens if you break this contract” page. Spelling out the consequences for breaking a contract does not make it part of the contract.

I’d really be curious which was its worded.

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23 Daddy Paul

Good topic. 5 years ago we had about 50% equity in our home today it is about 20% due to home devaluation. I am sure that someone who bought a 200K house 5 years ago with 5 % down and now has a 100K house and still owes 180K has got to be thinking about walking away. Home values will recover. It may take what seems like forever but they will come back.

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24 Credit Card Chaser

“The wicked borroweth, and payeth not again: but the righteous sheweth mercy, and giveth.” – Psalm 37:21

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25 TC

Some of the comments here, particularly fredct’s, are very thoughtful and reflect both a sense of responsibility and an appreciation for the effect that walking away has on surrounding properties.

I actually find that moral sense puzzling.

I have a mortgage, an agreement between me and a bank, a contract with economic effects and consequences.

This is not the same kind of agreement I have with my wife. We made oaths to each other that aren’t enforceable by law – they are entirely moral commitments, and I feel very strongly about keeping those commitments in the face of tragedy, adversity and even some betrayal. I have a moral obligation to meet my commitments unless and until they are unbearable, or we agree mutually to release each other.

It’s not at all like the moral commitment I have to my daughter. When I decided to become a father I accepted a responsibility for her until she reaches adulthood that is effectively absolute. There is no bankruptcy court or contract modification that can relieve me of that obligation. (Which, I hasten to add, I find not at all burdensome. She is on most days my greatest joy and my shining hope for a legacy.)

A mortgage is just a contract. There are half a dozen obvious ways to get out of it, starting with paying off the principal and depriving some poor investor of my moral obligation to provide a future revenue stream, (an obligation I obviously don’t have) and ending with simply not making monthly payments, waiting for an eviction process and accepting the economic consequences.

My obligations and the bank’s obligations are all defined in the same place, and that document itself proclaims that “this is the entire agreement” between the parties.

We shouldn’t confuse the moral obligations we have, and the moral commitments we make, with the economic instruments we use to exchange value. Not because it cheapens a mortgage, but rather because confusing them cheapens a marriage.

tc>

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26 Kristen

@TC, I guess I find it puzzling that so many people don’t think there’s anything wrong with walking away. I guess this reflects a new way of thinking in our society, “It’s all about me.” I agree that a mortgage is a different type of agreement from a marriage, but I also think that when you sign on the dotted line of the contract, you are making a promise. I believe in keeping promises — no matter to whom they are made — unless there is a very extreme situation in which you absolutely cannot. Quite frankly, if my husband were to suddenly decide that we should just walk from our home, I would question the kind of man I married.

Your said your mortgage has pages of remedies if you fail to pay. The bank is absorbing all the risk, and you’re absolving yourself of any risk or responsibility. Maybe there should be something in mortgage contracts going forward that if your house suddenly increases dramatically in value, the bank can kick you out, take your house back and sell it for more. That would be fair, right?

@Kristine, I do believe in karma, or bad joo joo, or whatever you want to call it. :) When it comes down to it, as I said in my original post, when someone walks, ultimately we all pay for it.

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27 TC

@Kristen, the bank and I share the risk. I have a substantial sunk cost (the revenue stream of the last 12 years of very regular monthly payments) and the massive drop in credit score that would result from default. The bank has the default risk we’ve been discussing (which is why they charge significantly more than the 0.25% to 1.5% they pay for money) and a lot of other risks we haven’t discussed.

If I have unexpectedly high expenses, or a prolonged loss of income, I risk losing the future value of the house. That’s too bad, but that’s the contract to which I agreed.

I’ve actually seen serious suggestions that one way to work out of the current crisis would be to let banks write contracts that increase the principal if the house appreciates significantly. I think that’s a not-terrible idea, though I don’t think I’d agree to a contract with those terms. Unless the cost of money on such an offer was really, really low. I might be more interested in a contract that included that clause, plus a matching clause that I could stop paying for six months or a year if I lost my job, or had a large healthcare-related expense. If the bank agrees to share my risk, I’d be willing to seriously consider sharing my gains.

Some people (particularly those who follow the Qu’ran – sorry I can’t quote the verse the way somebody quoted Psalms earlier) believe that any interest is not fair, period, so loans of this type are immoral. I don’t share their views, either. There may be too much diversity for a carefully calibrated moral argument around mortgages.

I’m curious: Do you share this moral sense for other externalities? Do you think it’s “immoral” to be overweight, or to drive a car that gets poor gas mileage? Do you think it’s moral to pay more for electricity from renewable sources? It seems a little like you’re using a moral sense as a substitute for addressing externalities through an economic mechanism. (E.g. by taxing them, or regulating against them.) That might also explain why the “it’s immoral” and “it’s a contract” commenters seem to be talking past each other. (Though this comment stream has been much better than some others I’ve seen. Much more civil!)

tc>

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28 Kristen

First, I’m glad things have remained civil. Sometimes we have to agree to disagree.

As far as the other questions you posed, I believe we have a moral responsibility to one another, and that can come into play in many forms. I don’t necessarily think it’s immoral to be overweight in and of itself because there are many people who have medical conditions or mental health issues that ultimately tie into their weight issues. But, if someone doesn’t take care to keep themselves in good health with what’s in their control, than I think there is a certain amout of immorality to that. It goes back to being self-centered. If you allow your health to decline when you have the power to change it, you could have a profound effect on your loved ones, and on the costs of health care, which can impact everyone.

As far as cars and energy, I have a hard time with that one because there aren’t a lot of options for greener sources of power. I certainly don’t think we should go out of our way to pollute the planet for future generations.

I’ll have to think some more about this on my drive home …

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29 Kristine

Great comments tc. I think you nailed it when you said “That might also explain why the “it’s immoral” and “it’s a contract” commenters seem to be talking past each other.” Everyone has their own perspectives based on their own beliefs and values. We all are only going to focus on the information that makes those beliefs and values true.

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30 fredct

For starters, I certainly agree on the appreciation that this thread has stayed civil.

For me – while the ‘externalities’ argument has some value (what does it do to the neighborhood, to home values, etc) – you don’t have to go nearly that far to show where its wrong. It’s simply in dealing with the immediate counterparty on the contract. You made an agreement to pay, and you’re breaking it.

I still feel – again, without a contract to look at – that the “this is what happens if you don’t pay” section is a section describing the remedies if you break the contract. Not a section that describes a legitimate option to leave it. In this way its much more akin to simply ceasing to pay a cell phone bill, rather than paying the ETF and canceling it. Both will result in the end of your service, but in one way you’ve followed the contract and the carrier will not have a claim against you, and in the other way you haven’t and the carrier will likely turn you over to a debt collector and impact your credit..

To use the health care analogy, it is not equivalent to being overweight. It is much more equivalent to seeking care that’s covered by your insurance, receiving the bill, and decided its in your best interests simply not to pay. The insurance company covered the care, you likely couldn’t've received the care without them, but now you’ve decided its in your financial best interest not to pay (and in many ways, you’d be right), so you don’t.

The same goes for your mortgage. You’ve received your house and lived in it for probably multiple years – something you could not have done without the bank. And now you’re backing out and breaking your part of the bargain. Even if its in your best interest, its still a slimy act.

Finally, ctreit said:
“Sometimes companies and even countries default on their bonds because it benefits them financially.”

Really? Can you name an example of a company or a country who defaulted on their bonds – not as part of bankruptcy and due to an inability to pay – but simply because they no longer cared to pay? I’ve never heard of such a thing.

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31 TC

@fredct, on your last question, Argentina in the 80s (and to a lesser extent in 2001) springs immediately to mind. In the former they simply stopped paying interest on state debt for largely political reasons; in the latter they got debt forgiven by threatening to stop paying. In both cases the government could have raised cash to continue payments, but chose not to for internal political reasons. We’re seeing a variant of that problem right now in Greece, where the government certainly *can* raise taxes and cut pension payments (there’s plenty of wealth there), but first has to deal with rioting in the streets. I don’t know how Greece will turn out.

The counterparty has remedies, and in most cases the lender writes the contract and controls most of the terms, so I’m inclined to let them live with the terms they wrote. If they mis-estimated their risk, too bad. The contract is the whole agreement between the parties.

All of this, I think, misses the point. We simply don’t agree on what is moral in an economic exchange. At one extreme, we have people who think any interest payment is immoral; at the other we have people who think any missed payment is immoral. We won’t agree on the morality, so we agree (through our legislatures) on contract law, and then on contracts.

The appeal to “you’re ruining your neighbor’s property value” is a moral appeal that can reasonably fall on deaf ears. Not because “this is all about me” but because we have a diverse culture that does not agree at the margins.

Do I recognize that I live in a larger world? Yes. Do I tend to do a little more than the contract requires? Yes, because I think there is some economic value to the goodwill that results. Do I think I have a moral responsibility to my neighbors? Probably not, yet I also recognize that all of us will have happier lives if we cooperate where we can, so I mow grass that might not be mine, and help clear snow that’s beyond my property line, and make donations to the Purple Heart people and volunteer for the PTA.

I’m one of the fortunate ones whose house is still worth more than I paid for it, in large part because I got in early. I have neighbors who are underwater on their mortgages. Do I hope they’ll stick it out? Yes, it’ll be good for me, and good for my whole community if they do. Do I think they’re morally obligated to stay? No, I don’t. Some of them will stay, because they’ll look at the whole cost of walking away and decide there is more value in staying. Some will make bad choices, hoping to get away from a bad mortgage, and will lose other assets and pay more for credit because they didn’t think carefully about the total effects. A few (I hope very few) will actually be better off walking away, and I think they probably should. And that makes me sad.

tc>

32 Kristine

I agree with Kristen’s viewpoint. If one is able to pay their mortgage, and they choose to walk away, that kind of decision has consequences. I understand that mortgage companies have clauses that protect them in the form of interest rates and having the home as collateral.

But, the main point of a mortgage contract between the homeowner and mortgage company is spelled out. The mortgage company loans you the money to live there, you pay them back every month. Choosing to walk away when you are able to pay is bad karma.

If you do choose to walk away, you face the repercussions of bad credit. Is it worth it to not be approved for loans or pay higher interest rates? This could mean a higher mortgage on your next home! Yeah, you stick it to the mortgage company now, but who really pays the price later?

We cannot control the market or the value of our homes. We can only control what we think and do.

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33 JCC

You people that play this moral game are just touching on the surface of what a contract is. Delve a little deeper into a mortgage contract and you will see that walking away is a part of the deal. If it states in the contract that the bank can take the property back if it doubles in value, then you better be aware of this. It doesn’t and never will say anything like that so that is a terrible example, Kristen. Nobody would sign a contract like that. Its the same with the car loan analogy. A car loan is completely different in what will happen to both parties if they default as opposed to a mortgage. It’s just a terrible analogy and people that use it are just ignorant. Also, being underwater in a mortgage prevents one from selling to be able to pick up and leave if they must. In today’s society people must pick up and leave all the time. If they were trapped in a mortgage contract just like 25% of the people in this nation and could not pick up and leave then that means total gridlock for the real estate market. Then what happens? That is why mortgage contracts contain walk away terms. These people that are so far underwater need to get out from these mortgages now if they think they will need to move in the next 5,10,15 years depending how long it will take for their homes’ to regain their value. Do you see what I’m getting at?
Also, the bank is not holding the bag on these mortgages where people walk away. In “fractional reserve banking”, which is what every bank uses in this country, the bank is borrowing the money to buy your house at an interest rate of less than 2%, and then loaning that same money to you at a much higher interest rate. So, if you have paid just 1 house payment you have made the bank money, not to mention those closing costs. Yes, it costs the bank money to foreclose but they will loan the money to someone else to live in the house, and continue to make money and eventually more than what it cost them to foreclose. And one more thing, people shouldn’t be complaining about their property values declining so much during this recession because they aren’t worth that much to begin with. You are mad because you are the ones that borrowed against your homes fake equity and now are left holding the bag.

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34 Kristen

I’ve had a lot going on today, but I wanted to comment on one quick thing:

“If it states in the contract that the bank can take the property back if it doubles in value, then you better be aware of this. It doesn’t and never will say anything like that so that is a terrible example.”

I don’t think it’s a terrible example. I was posing it as a hypothetical. If it’s okay for someone to walk because their house loses value, it should be fair for the bank to be able resell your house or raise your mortgage payments if the house gains value. And, as fredct pointed out, the remedies the bank can take if you fail to pay aren’t a clause that allows the homeowner to walk. Remedy means to rectify, to set right or correct a wrongdoing.

I think this a topic that some of us will never agree on because we’re looking at it from two different standpoints. And we all have different sets of values and interpretations of things.

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35 JCC

As a matter of fact its a dumb example because that hypothetical is so irrational. Supply and demand are pretty much what control who gets what in a contract and your hypothetical just totally ignores this theory. Why do you keep saying it is ok for homeowners to walk like there is no consequences. TC has tried to argue that point til he was blue in the face. Actually, all I did was restate what TC has covered in his posts, but just dumb it down considerably. The homeowner faces very severe consequences like their credit being destroyed and losing all principal that was paid down. What else should he lose. Let me guess, they should be forced to pay the difference by garnishing their wages, right? And how well off would this country and its economy be if that is what were allowed to happen? The big question is what do you propose the punishment should be for a homeowner strategically defaulting on a mortgage. It should be interesting to see what you say. Debtor prisons? Should they be forced to stay in the house by placing a 360 perimeter of SWAT forces around the house while also forcing the house payment from their bank accounts? The foreclosure laws for each state have been established over a very long time and are what they are for a good reason. Why is it only 13 of the 52 states are non-recourse? Why can you declare bankruptcy in this great country? Would you want a country where you were forever punished for making a mistake that is not intended to harm anyone or society as a whole? This country is great because people are allowed to be forgiven of their mistakes and start a fresh life. Maybe you should go live in a place where the consequences are much more severe for mistakes such as this and see how you like it. Please give me a solution to this huge problem of strategic default.

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36 Ryan

When did the US get two more states?

37 Kristine

@TC: I agree with your comments, especially… “Do I tend to do a little more than the contract requires? Yes, because I think there is some economic value to the goodwill that results.” Sometimes there may be no immediate return for this goodwill. But, I believe that you are sowing the seeds for future prosperity in doing so.

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38 Kirk Kinder

Kristen,

You could not be more wrong with this article. First, the contract is fulfilled even if you walk away. The contract lays out stipulations where you get the title to the house if you pay the mortgage principal and interest. If not, the bank takes possession of the home. In one of your replies to comments, you mention it isn’t fair to the banks because they get a home worth substantially less. Well, banks walk away all the time. Morgan Stanley recently walked away from a $5 billion commercial property because the value dropped. They obviously could afford to pay the mortgage. It just didn’t make any sense since the value dropped. The Mortgage Banking Association just did a short sale on its headquarters in DC, yet they tell homeowners to stay put even if they are underwater…hypocrites. Also, don’t the banks have some culpability here. They hire the property appraiser and make the borrower pay the appraiser’s costs. So the banks screwed up the property analysis, yet they expect the homeowner to sit in a home and overpay for years while the bank collects every penny of interest and loses not a penny.

Second, walking away does not hurt others in your neighborhood. Homes, like other assets, have an intrinsic value. If the current prices are above their intrinsic value, the market will bring the prices down. Using your logic, I should hold onto a stock that has lost value because selling hurts other shareholders by forcing the price lower. Why should we have any more obligation to a neighbor than someone who lives across the company. Markets find the appropriate price and foreclosures are a part of the market process…Econ 101.

Third, the credit score does take a hit, but we have excess rental units in the US right now. Rent prices are dropping so many landlords will be more than happy to take a renter with a job. Many landlords are looking past the foreclosure as they understand this is a different situation regarding foreclosures. Also, the homeowner can save thousands in rent compared to the higher mortgage payment, which will more than compensate for the hit on the credit score. Factor in how a homeowner in an overvalued home pays not only for the extra principal but the amortized interest. So if someone pays an extra $50,000 on principal, it really ends up as $100,000 when interest is factored in.

The other point that bothers me with this logic is that the unethical stigma is removed when a homeowner can’t afford the home due to a job loss or other event. If taking a mortgage is truly giving your word to pay, then it should stand even if you lose your job. There is no stipulation in the contract that says if you lose your job or have a disability that the bank won’t enforce the contract. Or, that they forgive your non-payment cause you lost your job. Using your logic, you gave your word to pay so the mortgage should be paid no matter what. Is it any less unethical if one steals after losing their job. It is still theft.

I am just amazed at how so many people have consumed the kool aid from the banking industry at how it is unethical not to pay your mortgage. Markets work best when all players act according to their best interest and within the contract, which a walk away does.

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39 The Personal Finance Blog

I don’t understand why it’s widely accepted for a corporation to walk away from a mortgage, while it’s supposedly immoral for an individual to do so. I didn’t hear any uproar when the investors behind the most expensive real estate deal in U.S. history decided to walk away from their loan. I’m referring to Manhattan’s Stuyvesant Town and Peter Cooper Village. This deal was financed to the tune of $5.4 billion in 2006; now that the complex is only worth $1.8 billion, guess what happened? They turned over the keys to the lenders.

Can somebody tell me what difference there is between a corporation walking away and an individual walking away? Legally, a corporation is as much a person as every one of us. So why is a corporation walking away from an underwater property a “business decision”, and an individual doing the same “being immoral and not owning up to their word”?

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40 fredct

I don’t think it is in any way widely accepted. If they walked away out of choice and not out of bankruptcy & inability to pay, then I don’t think anyone who takes issue with people doing it, wouldn’t also take issue with them.

The fact is, however, they claim they would have needed to file bankruptcy if they hadn’t walked away, so they may very well be in the ‘inability to pay’ area.

As to the previous commenter asking why its different… if you choose to walk away when you can pay, then you are making the conscious decision not to live up to your obligations (and unless someone shares language saying that foreclosure is part of the contract and not the result of *defaulting* on the contract, I maintain that that’s my understanding).

While if you have no ability to pay, you have no choice in the matter. While you likely made a mistake up front, you aren’t choosing to abandon your obligations when you could meet them.

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41 Kirk Kinder

It is widely accepted. Morgan Stanley just did it with a $5 Billion complex in San Francisco. They could afford to pay it. It just wasn’t advantageous economically.

When you make a contract for a business, property, or whatever, you need to understand all the outcomes and incorporate those outcomes in the contract. The bank does this. They know that people can stop paying their mortgage at any time. So, the banks have recourse by re-claiming the home or even going after other assets in some states.

The banks probably would not be in this position right now had they done their due diligence and required a substantial downpayment. Strategic defaults would not even be on the table if someone had put $50,000 into a home. The banks didn’t do that. They failed at the time of contract negotiation. So a homeowner who decides it is more economically feasible to walk away and rent should do so.

If I negotiate a contract with someone where I am at an advantage, it should not be seen as immoral if I utilize that advantage. This is no different. A borrower with no downpayment has an advantage.

As far as the choice argument, it is moot IMO. If paying the mortgage is a moral obligation, then it is a moral obligation even if you lose your job. You should have prepared for such an event. If I lose my job and steal bread for my family, am I not committing an immoral act? Is it any less wrong because I happen to be out of work? Maybe it is more understandable, but it is still wrong.

So the argument is either paying the mortgage is a moral obligation or it is a contract. There is no asterick where the moral obligation is waived if one loses a job.

The other faulty argument is how this hurts your neighbors when you default. Anyone who understands how markets work realizes this is faulty. Markets find the intrinsic value for an asset whether it is a home, stock, bond, etc. If a foreclosure causes prices to drop then it means the market was overvalued.

I remember a home going into foreclosure in my neighborhood during the boom. Yes, it did happen. The bank probably made some money. The foreclosure did not hurt the neighborhood value. So if a foreclosure hurts, it just means the houses were artificially inflated anyway.

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42 REK

Kirk, you are so right with your clear logical explanation!

43 TC

Tishman Speyer as a whole was in no real danger of bankruptcy; they did discuss taking that one venture through bankruptcy before deciding to simply default.

I talked to a real estate attorney after a PTA meeting last night, and she says that both strategic default and strategic shutdown of a venture (even with positive cash flow) are routine, particularly in the restaurant business.

If it’s not moral to strategically default, then it’s not moral for a business manager to decide to take a business through a strategic default. I don’t think companies have moral obligations, I think they have legal and contractual obligations, and the contract defines the limits of the agreement.

Fredct, I understand your argument. I don’t agree with you. I have access to any of the terms in the contract, including default. (As does the lender. I looked, and the lender can start repossession if I store rocket motors in my garage, even if I’m still paying.)

I think I’m among those who believe the economy is amoral. Morality is for people.

tc>

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44 fredct

> I have access to any of the terms in the contract, including default.

So you do confirm then that the language says that failure to pay puts you in default?

> I think I’m among those who believe the economy is amoral. Morality is for people.

Absolutely the economy is amoral. All the more reason why people need them.

Otherwise you end up with liar loans, and option ARMs that people don’t understand, and credit default swaps that no one cared about the risks of, and a housing & lending market collapse that causes millions of people to lose their jobs.

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45 TC

@fredct:

Yes, failing to make a payment is a default. (That’s the definition of a default in most cases. There are different kinds/categories, but I don’t keep track.) I think the main focus of this thread has been whether default is an economic decision, or a moral one, and that’s where we disagree. (For the reasons we’ve each explained previously.)

Liar loans are probably illegal, and if they were backed by an agency, they may be perjury. Option ARMs are pretty easy to understand, and work only as long as you’re in a rapid increase in housing prices. Why people thought that was a good idea is another thing I find puzzling. CDSs and CDOs don’t require fraud to work, but they need to be appropriately rated. The role of the ratings agencies is much more important than the role of borrowers in the collapse of the banking system.

Finally, I don’t believe that the credit market collapse is the cause of the recent recession and the resulting job losses. The collapse comes too late, and looks more like an effect than a cause. I’m impressed by James Hamilton’s work on the oil price shocks of 2007-2008, which come at the right time and are the right scale to trigger the 2008-2009 recession. The lack of jobs in the current recovery is more problematic and harder to address, but building more housing (when we already have an oversupply, according to builders) won’t recover jobs or housing prices.

I think economic amorality is best, if we can address externalities. (Which, coincidentally, gets back to where *I* started in this discussion.) I think an appeal to moral limits on externalities is a weak appeal, both for natural people (who may not share the same view of morality) and for corporate people (who balance market “good” against investor “good” and have legal and economic duties that tend to favor the investor or owner’s point of view.

Including externalities usually requires coercive measures. (Laws, regulations, etc.) Agreeing on coercive measures means politics. In a diverse culture like ours, that becomes challenging, and I don’t think an appeal to doing what *I* think is moral is helpful.

tc>

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46 JB

Kristen,
So the banks dont have a “We can take your house if it doubles in value” clause, but they did almost that with their derivatives trading. The banks caused the collapse of the price of my house, which I bought for 145K in 1998, now worth about 30K. Here is the analogy I use for what happened. I bought a home for 145K in 1998, but in 2008, the banks came into my home and trashed the place, they flung feces on every surface, flooded the basement, smashed all the windows, spray painted FOOL-IDIOT on the side of my house, and now my home is worth 20% of the price I paid 12 years ago. Then to add insult to injury, the government came along and felt bad for the bankers getting feces on their thousand dollar suits, so the government gave them a huge bailout to buy new suits, and new golf clubs, caviar dinners,etc. Now the banks tell me I am immoral for wanting to walk away from the mess they created, the economic decline they caused. Is it so wrong for me to say to the banks, YOU BROKE IT–YOU BOUGHT IT! The people who caused this financial mess should be in prison, but instead, they are doing the exact same things that caused the crisis in the first place, only they got raises since then, big raises while the rest of us lost jobs or took furloughs or cuts in salary. I would like to see your follow-up article why its immoral for banks to strategicaly default, how those who trashed hundreds of millions of homeowners home values should be in prison, but they aren’t, they are making more than ever before, trying to engineer the next economic crash/richboy bail-out.

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47 Juke

yup! Thats Me the Walk out artist Credit score is a 530, house is falling apart,only 30k In negative equity. I Make 100k per year. I have four kids, Im in constant danger of losing my job due to the unstable oilfield. What I pay in my mortgage pays 2 months rent on a small very modest home. I could buy a doublewide with cash in two years if I walk out and default even after I file banckruptcy. Thus giving my kids a better future for an education cause I’ll actually have the money to help pay for it. The cost of everything is going up but the actuall value is going down. Creditors have been dipping into my pockets for years. My wife supports my decision and looks foward to living in an old rent house out in the country. My house is over 30yrs old and yep I screwed up. I fell for all of the no money down first time homebuyer programs. I paid enough in interest last year that would have rented us a house for a year and a half. Yea I got a lil tax deduction, 2 of my kids are my step children that I cannot claim. and the child tax credit went from 2500 to 1000 per child. Which still left me oweing 7500 in taxes for 2010. Due to a 1099 during the slow times at work which I used the money to try to catch up on my mortgage instead of saving for tax time. Yep I’m one of those Irresponsible homeowners that keep crashing the Housing market. And go ahead feel free to pick on my grammer spelling typing education or the lack thereof. I wish I would have only stayed in my little trailer park house that I paid for through someone else defaulting. Man Those were the days. Sure I’ll pay for my mistakes but i’m not gonna let my kids Pay, as it is Obama Has ensured they would pay no matter what. I had no idea what I was getting into by buying a home, it was the worst mistake of my life.

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48 Juke

Oh Yeah I forgot to add that when I discussed the fact that my house was rotton and it was covered up when I bought it AS -IS My mortgage company told me to File it with my insurance company and if they denyed it to switch to another ins company and then file a claim with them. So they actually just gave me the advice to commit Insurance Fraud! And I’m the crook. Oh Well

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49 NORM KIMBALL

MY WIFE AND I BOUGHT A MOBILE HOME ON TWO ACS FIVE YEARS AGO,WE GAVE 30,000 CASH DOWN NOT BECAUSE WE HAD TO ,,IT WAS TO GET A SMALLER PAYMENT.WE PAID 145,000 FOR IT.NOW IT’S NOT WORTH 100,000 AND WE BUILT A 40BY 18 FOOT GARAGE HAD THE LAND INCLOSED WITH A FENCE,BUILT A SCREENROOM AND A BACK POUCH THAT SHOULD HAVE MADE IT WORTH MORE HERE IN FL.WE CALLED WELLS FARGO THAT HOLDS THE MORTGAGE TO SEE IF WE COULD REF. FOR A LOWER INTEREST RATE AND A SMALLER PAYMENT ,WAS TOLD NO BECAUSE IT WAS A MOBILE HOME,IT HAD TO BE A HOUSE THAT WAS BUILT,I SAID THE 30,000 DOWN PAID FOR THE HOME ,THEY JUST GAVE US MONEY FOR THE TWO AC’S.WELL THEY DIDN’T SEE IT THAT WAY,NOW WE DON’T KNOW IF WE SHOULD WALK AWAY OR NOT THE GAS BILL NOW IS FIVE TO SIX HUNDRED $$$ A MO.JUST TO GO TO WORK.WE ARE ROBBING PETE TO PAY PAUL DON’T KNOW HOW LONG WE CAN DO THIS.BUT IF WE WALK AWAY WE WALK AWAY FROM 50,000 OF OUR MONEY WE HAVE SPENT HERE,IT’S A HARD CALL SO BEFORE WE ALL SAY IT’S IMMORAL NOT TO STAY AND STICK IT OUT SOMETIMES IT’S NOT ALL ABOUT THAT..

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50 eddie

Here’s my dilema.

Sadly most of the homes in my neighborhood now (California, Sacramento area) were bought through short sale or forclusures – so I’m pretty sure the people who bought it got it for a very low price. In the meantime my house lost so much value that there’s no way for me to sell it. Now about a year ago due to salary reduction at my job I fell behind on my mortgage for 6 months but my bank was able modify my loan by reducing the interest rate from 5.4 down to 3.8%. Part of the agreement was to increased the principal and length of the loan due to back payments. Still I went ahead with the new agreement as I was able to afford the new mortgage. Until an unexpected expenses came up and then fell back to the same situation.

SO back to the negotiating table one more time – went through the same back and forth, more documents and paperwork but was told that no more program was available and was advised to do a short sale. Did it, got 10 offers but all were low (agent said due to the area I’m at there’s no way to get a higher value). Submitted the best offer to the bank and of course was rejected. But I still refused to give up so I applied again for another modification (against all hope) before they can proceed with foreclosure.

Got the latest offer 4 days ago and have 10 days to decide whether to accept it or not.

Here’s the terms of the agreement:

Rate stayed at 3.8 but the bank added the amount I owed to the principal while in negotiation (for 8 months) and on top of that the loan maturity date was extended to 2051 (40 year mortgage).

loan went up from 388K+ to 401K+

(from whatever I saved – payed most of my other accounts/bills/second mort will not budge)

So here’s my dilemma:

House is now worth 230K according to Zillow – but there’s about 7 more houses on the market in my street alone – third house is the same model as mine and it’s been on the market for more than a year now (that house is falling apart).

should I accept this new offer to fulfill my end of the agreement or should I walk away?

Thanks
Ed

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51 Don

First, business is business and there is no compassion or moral responsibility on matters concerning business. If you are in business your sole goal is to make a profit. To often as a nation we fail to understand that each person should operate their financies as if the were in business and when we are not able to meet our finacial obligations we must make tough decisions. Letting a house go may be one of those decisions is no different than shutting down a factory and moving it to china. Yes it is painful but to paint the picture that one is morally wrong does not take into account todays realities. Our children should be taught personel finance and how capitalism really works. These principals will better prepare them for the future rather than blinding them by some abstract principal that implies it is immoral to make a business decision that places you in a better financial position.

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52 rich

Rich,
Wow.
What a great read…all the above comments on walking or not – and the moral implications – or not. A few attorneys, bankers maybe here. Interesting. As a person in business my sentiments toward banks have changed. Or become more clear shall I say. Yes, they have all rights to stick to the contract…but at the same time, if one can’t get a refinance on a current mortgage with a given lender, and existing terms are not market rate, and the lender won’t budge, it can be a tough call. All else aside, they have in essence “a mortgage” on ones financial future health if they won’t negotiate. And in “victim speak” the lender can (I won’t say should) renegotiate to a current market rate and still be whole. Can the same be said for the borrower who might be stuck.

The mega banks had their way with credit card portfolios…loan sharking rates to card holders who might have missed a due date once or twice…but nevertheless paid (I get the personal responsibility angle) but then gets financially driven into the ground because “they can”…meaning the banks. Banks, banks, banks.

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53 Brenda Coach

If someone own a home that is under foreclosure and do not have plans on paying the back taxes, would it be in their best interest to give it to someone else who is willing to pay back taxes?

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54 Fred

You generally cannot “give” someone a house… Or, well, you can, but its considered a gift of the market value of the house, which will certainly be way above the $13K annual gift tax exclusion. So the giver will end up owing gift tax, or at least take a significant bite out of their estate tax exclusion.

I figure you’re trying to do something ‘clever’, but why not sell the house to that someone? If you have a mortgage on the house, ‘giving’ it away for less than what you owe is essentially a short sale which the bank would have to approve. It’s pretty unlikely they’d approve it unless you can pay the balance off before you sell.

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55 WOODROW

What if the neighborhood has become “UNSAFE” and one “fears” for one’s life and THE HOME IS WAY UNDERWATER TO THE TUNE OF 60,000? WHAT’S THE POINT OF KEEPING ON FOR ‘MORAL REASONS”?????? CONCERN FOR MY DAUGHTER!!!!!!!!

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56 Ryan Guina

Family safety always comes first. It’s easy to say things are black and white until you look at the full situation. There are almost always shades of gray.

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