Morality of Strategic Default in Home Loans

[freerf]

Anyone want to chime in on the morality of this subject?

Let me define strategic default: choosing to no longer pay a home loan despite the ability to pay, with the intent of forcing the loan agent to renegotiate the loan terms, short-sale, or forclose.

Many of my Christian friends say this is an immoral thing to do. I think it’s not so black and white.

1. You are under contract to pay a loan - “promise to pay” - but this same contract has terms for default. The contract explicitly states what happens if you no longer pay.
2. It is completely legal (yes, that doesn’t make it necessarily moral).
3. The banks mislead the public trust when making many of these loans. They knowingly allowed many, many unqualified borrowers mortgages, thereby inflating the market, and creating this instability and bubble. All homeowners were affected, not merely the ones foolish enough to take a bad loan.
4. If you live in a dangerous neighborhood, but can’t sell, nor rent, what do you do?

Anyway, I’m interested in your opinion, especially ones which use scripture.

 

[Alix1912]

Anyone want to chime in on the morality of this subject?

Let me define strategic default: choosing to no longer pay a home loan despite the ability to pay, with the intent of forcing the loan agent to renegotiate the loan terms, short-sale, or forclose.

Many of my Christian friends say this is an immoral thing to do. I think it’s not so black and white.

1. You are under contract to pay a loan - “promise to pay” - but this same contract has terms for default. The contract explicitly states what happens if you no longer pay.
2. It is completely legal (yes, that doesn’t make it necessarily moral).
3. The banks mislead the public trust when making many of these loans. They knowingly allowed many, many unqualified borrowers mortgages, thereby inflating the market, and creating this instability and bubble. All homeowners were affected, not merely the ones foolish enough to take a bad loan.
4. If you live in a dangerous neighborhood, but can’t sell, nor rent, what do you do?

Anyway, I’m interested in your opinion, especially ones which use scripture.

Response to your scenarios:

1 and 2. You signed a contract to borrow money, which the bank loaned to you, you agreed upon the terms and interest rates at which that money was to be paid back. The default terms are there to explain the consequences of not paying the loan. If you have the money and refuse to pay, you are basically breaking your word, which is morally wrong. Not to mention, you could land yourself in a world of financial trouble, including but not limited to a trashed credit report or garnished wages, or even an intent to defraud lawsuit. (All of which would be rightly deserved). Also defaulting on your loan, depending on the terms can actually not be legal.

1. Just because some mortgage lenders, and banks engaged in predatory lending, and some consumers chose to take out mortgages they could not afford, does NOT give you the right to defraud any bank you are doing business with even if they were one such bank. All banks are not EVIL. Most predatory lenders sell the mortgages they write to toher institutions in batches of many different types and kinds of debt. So defaulting on a current loan probably isn’t going to “stick it” to the person who got you to sign the papers in the first place. Again this is an unethical and morally wrong reason to attempt to justify your actions. Two wrongs don’t make a right, saying that doing something wrong to another person who did wrong is Ok is like saying it’s OK to steal stolen property from the original theif. Also the concept of “sticking it” to someone is essentially revenge which we are explicitly told is wrong in the Bible. Keep in mind that the immoral actions of small groups of people often affect many innocent people, but that is also not justification for the innocent people to act immorally.
2. Unless your neighborhood turned bad overnight, you probably were aware of what was going on. Also again the Bank agreed to loan you money, it did not agree to make sure that your home was perfect, or in a nice neighborhood. That is you and your realtor’s problem.

It is never moral to purposely go back on your word because it is more convient or profitable for you to. If you can pay your mortgage, but simply don;t want to, that is not OK. If you are having financial difficulties you should contact the institution that owns your mortgage and negotiate with them up front.

Also I’m not sure you are going to find exact scripture quotes on not defrauding a bank.

 

[Caffeinated]

I actually agree with freerf in that I don’t necessarily think it’s black and white - if you are looking to get out of the contract because you need to move for some reason but cannot negotiate with the bank, cannot rent it enough to cover the mortgage, cannot do a short sale (as you do not qualify for the hardship situation) and cannot sell it at a loss because you can’t come to the closing table with the price difference, and the bank is not equipped to deal with those kinds of specific cases, you may not have any recourse but to walk away - if your goal is not to force the bank into renegotiating but to get out of the terms altogether. If you live in a non-judicial decision state, the bank cannot go after your assets or garnish your wages or such. The way the contract is written, if you default on the contract, the bank gets the house - which may be the only option possible if you need to get out of the house. You are basically prohibited from getting a new home loan for 6-7 years and your credit is damaged.

 

[puzzleannie]

1. The banks mislead the public trust when making many of these loans. .

what some banks did with some loans is not the concern here. Your concern is your loan with your bank, the terms of that loan including what happens if you follow this plan. If it is legal it may or may not be moral as you say. Tell me again how leaving a house empty because you cannot pay the mortgage is going to help you financially pay for another lace. that is the part I don’t get. If you bought a house in an undesireable location or with features that make it hard to sell, that was your choice, for which you had good reasons at the time, but if a consequence is that you can’t sell it, that is part of the cost of home ownership.

if the bank is refusing to negotiate or otherwise comply with the law, that is another story, but you should get legal help before acting to protect yourself.

 

[Will_S]

I actually agree with freerf in that I don’t necessarily think it’s black and white - if you are looking to get out of the contract because you need to move for some reason but cannot negotiate with the bank, cannot rent it enough to cover the mortgage, cannot do a short sale (as you do not qualify for the hardship situation) and cannot sell it at a loss because you can’t come to the closing table with the price difference, and the bank is not equipped to deal with those kinds of specific cases, you may not have any recourse but to walk away - if your goal is not to force the bank into renegotiating but to get out of the terms altogether. If you live in a non-judicial decision state, the bank cannot go after your assets or garnish your wages or such. The way the contract is written, if you default on the contract, the bank gets the house - which may be the only option possible if you need to get out of the house. You are basically prohibited from getting a new home loan for 6-7 years and your credit is damaged.

The question is not really about living arrangements; it is about debt. When you borrow money, you have a moral obligation to pay it back. Someone whose property is worth significantly less than the mortgage, and thus unsellable, who has to move should try to arrange to rent the property to help pay the mortgage payments, even if the mortgage payments exceed the rental market value of the house.

If that is impossible for some reason, and the owner truly has no option but to just leave the propery without paying the mortgage, that still not not relieve him of the obligation to pay his debt. Assuming the property is foreclosed upon and eventually sold, the previous owner is still morally obligated to pay any remaining balance of the debt after the sale. Obviously however, it is possible that this obligation could be reduced or even eliminated by negotiation with the lender.

 

[AlanFromWichita]

Just a side issue – if a bank forecloses and makes a profit on the sale of a home, is the excess returned to the lender – to pay back payments and/or compensate them for the loss of the equity? Seems I’ve heard horror stories of banks foreclosing on nearly paid-off loans with lots of equity, when the person fell on hard times, then the home was taken and the bank made a huge profit.

Alan

 

[Link0126]

Morally wrong.

 

[tafan]

Anyone want to chime in on the morality of this subject?

Let me define strategic default: choosing to no longer pay a home loan despite the ability to pay, with the intent of forcing the loan agent to renegotiate the loan terms, short-sale, or forclose.

Many of my Christian friends say this is an immoral thing to do. I think it’s not so black and white.

1. You are under contract to pay a loan - “promise to pay” - but this same contract has terms for default. The contract explicitly states what happens if you no longer pay.
2. It is completely legal (yes, that doesn’t make it necessarily moral).
3. The banks mislead the public trust when making many of these loans. They knowingly allowed many, many unqualified borrowers mortgages, thereby inflating the market, and creating this instability and bubble. All homeowners were affected, not merely the ones foolish enough to take a bad loan.
4. If you live in a dangerous neighborhood, but can’t sell, nor rent, what do you do?

Anyway, I’m interested in your opinion, especially ones which use scripture.

1. Is an invalid premise. Almost all contracts have terms and conditions for when a breach of contract by one of the parties occurs. That does not make the breach of contract acceptable. If you look at the language of the contract, the terms for default are in no way worded so as to allow for a default to be willingly chosen.
2. I am not for sure this is true. Willingly breaching a contract is certainly illegal under civil law, I do not know if there are any conditions where it is under criminal law (ie, the state could also prosecute you and impose fines/prison). Nevertheless, you state youself, it is meaningless to the question.
3. Complete, utter hogwash. The vast majority of homeowners understand the basics of their loads, ie what the interest rates are, the monthly payment amount, how much principal is on the load initially, is it a floating rate. Banks may have been over agressive in selling these loans, implied promise of refinancing, etc. And how were all homeowners affected?
4. This is a difficult situation. There might be situations where one is morally justified in defaulting on the loan; for example one looses their job and doesn’t have the money, and maybe the situation you describe. But just because your home is less in value than the loan you took out, that is not sufficient.

I am not going to go to scripture, too hard. I will go to the catechism:

2410 Promises must be kept and contracts **strictly **observed to the extent that the commitments made in them are morally just. A significant part of economic and social life depends on the honoring of contracts between physical or moral persons - commercial contracts of purchase or sale, rental or labor contracts. All contracts must be agreed to and executed in good faith.

2411 Contracts are subject to commutative justice which regulates exchanges between persons in accordance with a strict respect for their rights. Commutative justice obliges strictly; it requires safeguarding property rights, paying debts, and fulfilling obligations freely contracted. Without commutative justice, no other form of justice is possible.

It is wrong. You are stealing from the bank. Very likely a mortal sin in most circimstances. Many of your Christian friends say it is so, because it is obvious. And your reasoning, items one through three at least, is horribly flawed.

 

[tafan]

I actually agree with freerf in that I don’t necessarily think it’s black and white - if you are looking to get out of the contract because you need to move for some reason but cannot negotiate with the bank, cannot rent it enough to cover the mortgage, cannot do a short sale (as you do not qualify for the hardship situation) and cannot sell it at a loss because you can’t come to the closing table with the price difference, and the bank is not equipped to deal with those kinds of specific cases, you may not have any recourse but to walk away - if your goal is not to force the bank into renegotiating but to get out of the terms altogether. If you live in a non-judicial decision state, the bank cannot go after your assets or garnish your wages or such. The way the contract is written, if you default on the contract, the bank gets the house - which may be the only option possible if you need to get out of the house. You are basically prohibited from getting a new home loan for 6-7 years and your credit is damaged.

I do not think the OP would include the “needing to move” under the idea of strategic default. Yes, I know someone that was unexpectedly transfered in the military and had no way of selling the house, he had no choose but to default. That is different, than a “strategic default”, which implies you are doing it to simply come out financially ahead (eg, people who bought second homes in Flordia and quit making payments because the house dropped in value and they didn’t need to live there; or the people on my block who quit making payments just to live free for 12-24 months while the bank gets around to foreclosing).

 

[Godfollower]

The sinner shall borrow, and not pay again; but the just sheweth mercy and shall give.

Psalm 36:21 (Douay-Rheims).

The wicked one borrows but does not repay; the righteous one is generous and gives.

Psalm 37:21 (New American Bible).

(It’s actually the same scripture, in traditional and more modern English; the numbering system is different).

 

[newsocrates]

Hello,

I would like to recast this discussion along the lines of a different set of concerns. I agree that, all things being equal, it would be immoral for someone to deliberately breach his or her contract to repay a loan by not paying, thus forcing a number of consequences that basically amount in fraud.

However, these responses focus on the obligations regarding the borrower who enters into a valid contract and makes a promise in good faith to repay the loan. What about the obligations of the lender though?

The lender has three general obligations. The first is to lend money in a reasonable way. For example, the lender’s responsibilities involve pre-qualifying a borrower to ensure that a loan can actually be repaid. It also involves lenders ensuring that the loan is serving the common good rather than simply an attempt to exact interest for profit. Common sense should be sufficient to help people see why a lender can and should exercise great care before issuing loans to be sure those loans have a reasonable shot at being repaid.

Secondly, the lender must have sufficient capital to make the loan. It is immoral to lend money that one doesn’t have. Further it is immoral and grossly unjust to suppose that one institution, namely the banking industry, has a monopoly on creating money for the sake of lending. If a lending institution can bring together a lender with sufficient capital and a buyer with sufficient means of repaying the loan, then there is no harm done assuming the purpose of the loan doesn’t undermine the common good. But, as was the case with many banks during the housing bubble, the banks did not have sufficient capital to lend to borrowers. They created the money arbitrarily because these loans were backed by the federal government. I will return to this in a few lines because I see this is a serious breach of good faith n lending.

Third, at least according to Catholic teaching, it is immoral to exact interest on certain loans (usury). For example, if a loan is made in good faith that is designed to help a borrower produce goods and services that will lead to a greater distribution of wealth, then it is morally acceptable to exact a reasnable interest rate. Since the loan is directly helping produce profitable goods and services for the borrower, distributive justice demands a repayment with a share of those profits to the lender.

However, in the case of lending money to buy a home, this seems highly suspect of being usury. The loan does not help the borrower produce anything of financial benefit. It does provide a home, which is a basic need, though. Yet the home does not produce income but rather extracts income. The spurious assumption behind interest exacted on mortgages is the assumption that a home is an “investment”. Yet it can only be an investment if housing prices rise. Yet the only way to make housing prices rise is to lend more easy money for buying homes. It becomes a vicious cycle that ensures a flow of interest for the banks but leaves many consumers devastated.

The immorality of this process should be evident to all. Banks are creating money arbitrarily, lending it out to borrowers who are not producing anything with this money (the loan is for consumption, not production), and then the banks are exacting interest. This, to me, is usury. I could be wrong, but I see no other way around it.

Now if the contract is based on usury, it raises additional questions about the validity of the contract to begin with. Naturally, if the contract is invalid because it is based on usury, then it follows that a strategic short sale, for example, may not be immoral but in fact a legitimate mode fo resistance for a homeowner who initially “drank the cool aid” but has come to his senses and is trying to protect his family. At least this is my thought process right now.

I am not sure where I stand on this issue entirely. But the issue isn’t as black and white as just saying, “it’s immoral to break a promise to repay a loan.” It ignores the immorality of the mortgage business, mortgage contracts, and the question of usury in the present state of affairs.

I would be more than grateful for anyone’s insights on this.

 

[manualman]

Defaulting as a strategy for personal gain is clearly immoral. Who do you think is hurt when you default? Some big Wall Street fat cat? Yeah, right. Those guys always protect themselves fully. The ones who get hurt are your NEIGHBORS whose property values decline further due to the low foreclosure sale price, and your OTHER neighbors, the ones who placed their deposits in bank savings accounts and see little to no interest on that savings dues to massive losses the bank incurs and your OTHER neighbors, the ones with the 401ks and mutual funds that hold shares in the banking companies taking those losses.

The only ones that DON’T get hurt are the criminals who manipulated the system for their own gain. THEY got bonuses from our tax money via bailouts. Nice world we live in.

Bottom line: Don’t engage in actions that make a problem worse for everybody else just to get a short term benefit yourself. That might just be one of the textbook definitions for sin.

 

[newsocrates]

Thank you for your response. However, I’m wondering if you may have missed the point of my post.

I am not suggesting that strategic default is morally acceptable. I suggesting, or at least pondering, that mortgage contracts, used to facilitate the buying and selling of homes, is in fact usury, and immoral to begin with. If so, the contract is invalid, and further, there can be no strategic default since the contract is invalid.

This is a highly technical question. The church doesn’t have a clearly defined position on usury. I am at present though, inclined to accept Aquinas’ position, that loans made for consumption that require interest are usury and sinful, especially if the consumption revolves around a basic need, such as housing.

This teaching has strong implications when put within a modern backdrop where people are either forced to take out large mortgages or rent in order to obtain basic housing. Both of these options are serfdom as I see it, and especially in the case of mortgages, they can be financially devastating to families if something unexpected goes wrong, such as with unemployment.

Why people trust banks with their personal savings is beyond me. A bank that charges interest is a bank that lends money out at risk- why deposit it? why trust the government to back you up? Again, we are dealing with usury.

We need to think outside the box of modern banking if middle class families are to have the opportunity for real freedom.

 

[JimG]

Just a few comments. In fact, many, perhaps most, mortgage lenders, in effect do loan money that they do not have. They are in the business of originating loans, not holding them.

These lenders have a line of credit with a larger bank which funds the loans at closing.

Now it is also true that in the past decades many homeowners and homebuyers in fact did use home loans to generate personal income. The bought homes specifically based on the assumption of rising prices. They then refinanced those loans every few years at a higher amount, taking out some of the equity in cash to buy other things, or even to help finance the purchase of other homes for investment purposes. Those borrowers did in fact use their homes as a cash generating machine. I recall one guy who told me that he had made more money over the years buying (and selling) his own personal residences, than he had made in salary.

Now, even if a homebuyer uses a home mortgage for the sole purpose of acquiring and keeping a single home, with no intent to take cash out by refinancing, why would the charging of interest be immoral? From the lenders standpoint, the money lent is the same whether the homeowner intends to occupy the home for thirty years or whether he intends to refinance it in 4 years and take out the highest amount of cash possible.

In the early parts of 20th century it was not at all unusual for individuals of modest means to own individual mortgages which they had purchased from building and loan companies. Instead of drawing interest on a savings account, they bought someone else’s mortgage and had monthly income from it. It would be an injustice to have them pay for a mortgage and receive no income.

Now, of course, most lenders do not sell mortgages to individuals. Rather, they pool them together and sell them to large companies. Those companies may use the mortgages as collateral for bonds (such as GNMA bonds) which can be bought by individuals or by pension funds to generate income.

Whether buying an individual mortgage or a piece of a pool of mortgages, there is a risk that the underlying borrower will default. The risk is increased if credit standards are overlooked, as they certainly were during the recent housing bubble. And risk is something that the owner of a mortgage or a mortgage backed bond inevitably assumes. A company or pension fund holding mortgages or mortgage backed bonds doesn’t particularly care why a default occurs, only that it occurs, and if it does, how big is the risk?

Some loan servicers will actively seek out alternatives to foreclosure, such as short sales, or deeds in lieu of foreclosure, from borrowers who might otherwise default, because foreclosure is expensive. It’s all a part of the business.

I suppose one way to look at the ethics of it is this: If a homeowner gets to keep the profit from a home’s appreciation in value, he also runs the risk of losing money from a decline in value. But that’s a risk that not all homebuyers are equally prepared to take.

 

[JimG]

I suppose one way to look at the ethics of it is this: If a homeowner gets to keep the profit from a home’s appreciation in value, he also runs the risk of losing money from a decline in value. But that’s a risk that not all homebuyers are equally prepared to take.

PS–I might add that it’s not a risk that all companies are prepared to absorb either. As a result of the bursting of the sub-prime mortgage bubble, many big companies stood to lose billions of dollars, some of them did lose billions of dollars. Yet in the end, the government was unwilling to see them go under, so the taxpayers stepped in an absorbed those default losses!

 

[newsocrates]

Hi JIMG, thanks for your thoughtful response. A few comments about your comments…

1. that most mortgage lenders originate loans but in fact have a line of credit from banks which fund the closing, is a separate issue. The issue that I am challenging is the moral legitimacy of money lending, and the exacting of interest, for the purpose home ownership. I am also not really concerned with investment properties here.

In our society there are three basic ways to live in a primary residence, which is a basic human need. One can rent from a landlord. One can finance a home/cooperative purchase from a bank or other lender. Or third, one can pay with personal savings. I can’t see how the first two options are anything but serfdom. Yet for most people these are the only two options.

Most people are forced to do one of the first two options. I believe this is usury because housing is a basic need. Forcing people to accept loans or rent, and then exacting interest on the loans, in order to satisfy a basic need, I think can be called extortion. I can’t seem to find any convincing argument to the contrary. Yet our society sees this as “normal” and of course it is “legal” even though this is a relatively recent phenomenon in western culture. Yet what is normal and legal is not always morally sound either, as in the case of abortion.

1. People who use home loans to generate income. This is a separate issue. If the loans are used to produce goods and services that translate into profits, then the lender is fully justified in exacting a reasonable interest as a share in those profits. The profits wouldn’t be possible without the loan. This belongs to commutative justice. I am talking about loans for consumption. A primary residence falls into this category. And homes are not “investments”. They are dwellings that provide shelter for families. Banks want us to believe they are investments so that we borrow money, which creates demand, which inflates prices, and they of course can extract risk free interest. In the end they just create money artificially to bail themselves out if too many people default. At least this is the current practice. Why do banks have this monopoly on credit creation? Why do they have no risk but we do?

You mentioned people with modest income in the early 20th century used these loans to finance houses. The fact so many people had to crawl to the “potters” of that time period is highly suspect. It shows a failure of distributive justive, where the means of ownership are controlled by a relative few at the expense of the many. I guess some things never change! Why is that banks alone have money to create money and finance houses for people to live in?

However, whether banks are justified in charging interest to those who are using home loans to further invest in real estate is a difficult question. It is like asking, “is it morally justifiable for a gay male prostitute to use a condom?” Condom use, and male prostitution are undoubtedly immoral, but as Pope Benedict XVI recently stated, maybe it’s morally licit for the gay prostitute in the sense that he is at least showing some concern over his actions. In that context of evil, maybe it’s the closest thing we will see to a morally upright action, I don’t know.

While an odd analogy, I admit, it’s a similar issue with the vast network of mortgage driven real estate investing. Given the normalcy of the situation, I suppose it is just for the banks to draw interest in this way. It’s good to see that the banks have some concern over justice. Yet, what I am questioning is something deeper: why do we even have this system and is it serving the common good? This whole system stinks of greed and usury.

1. I would encourage you to check out the catholic encyclopedia on the subject of “usury”. You can google it online or go to newadvent.org then look up usury. It’s not a clearly defined issue, but one thing is certain: you would be hard pressed to find in the Fathers or the medieval doctors that would support the current practices of the modern banking/mortgage industry. The modern church seems somewhat silent on it, and I admit it’s an open ended issue.

Remember, just because something is common practice, doesn’t make it morally acceptable. If these practices are not morally sound, then the contracts are invalid, and if so, not paying may in fact be the morally appropriate thing for people to do who are looking to break the chains of financial slavery.

It isn’t strategic default though. That would be to acknowledge the terms of the contract. I suppose it would be something more like Jean Valjean taking the loaf of bread back from the baker in Les Miserables who was holding it for the wealthy.

 

[newsocrates]

Now, even if a homebuyer uses a home mortgage for the sole purpose of acquiring and keeping a single home, with no intent to take cash out by refinancing, why would the charging of interest be immoral?

It is suspect of being immoral on a number of fronts. The home in this case is not producing any goods and services. It is providing shelter for a family, which is a basic human need, even a “right”. Exacting interest in this case is a violation of commutative justice. What is returned to the lender is grossly disproportionate to what the borrower has aquired. Since there is no profit produced through the use of the property, what claim does the bank have to any interest?

Now, for example, if a guy started a small-scale family farming business with his loan that is a different story. The interest, so long as it is reasonable, would be fully justified, as it would be a partnership that made possible the business venture. But a shelter for a family is not an investment. It is not designed to produce profit.

A case in point. A 30 year old husband and father of 3 children buys a $200,000 home. He puts down 10% and finances the rest with a 30 year fixed mortgage at 5%. “Better to buy than rent he reasoned”. “At least I’ll get the tax write off, he reasoned”. “At least I’ll own”. At the end of the 30 years, he has the consolation of knowing that he paid more than double the sale price of his home. This doesn’t include the countless repairs, etc that he had to pay for and perhaps a few home equity loans along the way that he was compelled to take out because he had no personal savings. Why did he have no personal savings? Because he was always in debt paying the bank.Because he was always in debt with the mortgage he needed to continue to run deficit spending programs to support his household. That is why he has 10-15K in credit card debt but thinks nothing of it. He thought he was making an investment though and looks back proudly when he owns his home “free and clear” even though he lost more than $400K just in the home purchase, not including other debt related to this decision, such as home equity loans, credit card debt, etc! He thought all this was “normal”. He has to “hope” that his equity more than doubles in order to at least recover that if he ever sells. People who own today know that that’s a pretty tall order. And of course, the whole system becomes self serving. In order to get an increase in that magnitude, banks need to create more easy loans to drive up demand and home prices. And of course, banks continue to take their interest off the top of each loan.

On the contrary, this is an immoral system peddled by banks at the expense of ordinary families. It doesn’t serve the needs of these families, one of which is financial independence which creates the conditions for maximum religious liberty. The amount of interest collected on the loan is far more than the price of the home making it an uneven exchange of goods. Not to mention the lost savings in not being able to save because most of the money was going to the bank.

But he “had” to finance with the bank. What else could he do? Rent? Live off the land? Build his own house with sticks? Yet a condition in which one is forced to borrow and pay interest for a basic need where others have a surplus available (such as a surplus of money or property) is a form of usury. Legally we might call it extortion. I say it is sinful.

I know our society doesn’t see it this way. But that doesn’t change what it is! None the less it creates a lot of implications for those who find themselves in compromised positions financially and decide that they are going to respond by simply not repaying their loans. Would the 30 year old guy above be wrong to disregard his loan “contract” so that he can better support his family? I don’t know.

What I do know is that it isn’t so black and white.

 

[JimG]

What possible difference does it make to a lender whether the proceeds of a loan are used to buy a residence for personal use, or to buy the same home as a base for a business, or to buy the same home as rental property? It’s the same amount of money going out from the lender to the borrower in any case. And the lender has no control whatever as to what the borrower does with the home. He may change his mind the next day, and turn it into a rental or a business, or change a business into a home.

Are you saying a lender should charge interest on business loans and farm loans, but is due no interest whatever on loans for the purchase of a personal residence? That would be one sure way to dry up the housing market pretty quickly.

A buyer, in any case, should not be making a buying decision based on the deductibility of interest. And unless there is a pre-payment penalty, a buyer has the option to pay down the mortgage debt faster than the loan term, thereby reducing the interest payments.

There is nothing at all wrong with renting instead of buying. Sometimes it’s the best thing to do, particularly in markets where housing prices are falling. Why own a declining asset? Even when a home is completely paid off, you are still “renting” in that you have to pay the real estate tax every year or face tax foreclosure. Even when it’s yours, it’s not entirely yours!

As to why banks can create money and I can’t, that’s the way the law is set up. In the past I think some banks issued their own money, not U.S. currency. But then one had to decide which bank’s money was less risky. I don’t like the speed with which Ben Bernanke creates money, but I’m not sure that I want each of us doing the same thing.

And what about construction loans? That’s money lent for useful work, but when the construction is complete, the construction loan must be paid off by selling homes. And homes are sold either for cash or with permanent loans. A bank can make a construction loan and collect interest, but then shouldn’t charge interest on the home loan? Again, that would be a recipe for a lot of unsold homes and defaulted construction loans.

A lot of people guessed wrong on the direction of housing prices. They will no doubt guess wrong about the direction of other price trends. Money will be made and lost because of it. But if you’ve got a better way to finance homes, I suppose there will be some customers out there waiting for you.

 

[newsocrates]

I would say that the difference is one of “ends”. The purpose of the loans are different. That banks don’t bother to consider the end or purpose of a given loan is just further evidence of the blatant disregard of the demands of justice in the area of exchange. Again, we can draw a simple distinction between loans made for consumption and loans made for production. Primary residences are loans made for consumption. The home is not an “investment”. It satisfies a basic need for the family. For those with a surplus of money or property to withhold this from those who do not have it, and then issue loans and exact interest is sinful. I’m not sure how else to put it.

We can draw a similar analogy with food. Suppose an individual had a great storehouse of food. Yet there was a great famine and many around him were starving and did not have food. Do you think it would be morally acceptable for him to issue loans for the food and charge interest on those loans? Do you think it is morally fitting for him to withhold using his stock of food for the common good since it’s his “private property”? Then imagine some clever folks taking out loans for this food, and then “flipping” the food by selling it to more impoverished people who really wanted it and were willing to pay a higher price. Do you think that basic housing is less of a need for a family than food? They are both important and they both require money/credit in the modern world. Yet as long as banks monopolize this area of exchange, they will be able to use extortion with the full force of law.

This is the problem with modern banking. Banks have a monopoly on the the money supply, or credit, which is needed to pay for basic housing. This need is exploited through the use of loans at interest which keeps these home owners dependent on the bank for additional credit in the future. They are quite literally “death pacts” which usually end in disaster the first instance something goes wrong. The ‘homeowner’ is rarely ever able to move capital in the form of money away from the banks into real savings for his family.

I personally have come to the conclusion that the whole concept of issuing a loan to buy a house is just as cynical as forcing someone to take out a loan to buy food when he is starving. It’s a basic need. It’s wrong to exploit that need with a loan, let alone interest. The Fathers of the Church and Aquinas seem pretty clear on this issue. The housing market would most certainly come crashing down in these circumstances, but that would mean more people could afford to pay cash for homes, which is a good thing. We reduce servile dependence on the banks. It would also discourage rental and investment properties and convert those properties to primary residences, which is further a great thing. Rental properties are just another means of serfdom. A society with widespread distributive justice would see very little, if any rental properties as there would be a wider distribution of property/ownership. And, as Leo XIII clearly teaches it is good when people own their own homes and the means by which they can procure their own livelihood through stable work.

The truth of the issue is that if you remove the banks from the equation, housing prices would probably be very low and reasonable and more people would own outright. The loans that were in force would spur small business ventures and family owned enterprises, further distributing wealth more broadly. Credit would be issued for production, rather than consumption, leading to growth in local communities. Corporate america probably wouldn’t like it, but oh well…

About the real estate tax- I see what you are saying in that ultimately the “public” owns the property. However, this is not unjust because ultimately private property is for the good of everyone. A land tax is just because when one builds a house on that land he is removing the possibility of productivity from that piece of land. It is just then that the public lawfully imposes a reasonable tax for the use of that land, with the proceeds serving the common good in some appropriate fashion. Yet this tax is not a despotic control over the property either; the home remains the private property of the owner, to be used for his own livelihood.

About construction loans…The loans made to construction companies to complete the work would, following Aquinas’ distinction, be considered loans for production. Assuming you had a buyer willing and able to pay for this service, I see no issue. He can pay the builder in a mutually agreed upon way that allows the builder to earn a just compensation for his work. The builder then repays the bank, with just interest since the bank partnered to help him complete the task and earn a profit. The bank shares in the profits of the construction firm because they helped make the job possible through extending credit to purchase the materials. I don’t see what is so bad about this arrangement.

The problem today though is that since the banks, through their unscrupulous lending practices, have driven up the price of new construction to absurd levels, most people could never proceed in this fashion because they can’t afford to pay cash for their home. So we assume that we “must” take out a loan from the bank- at interest- to make it work, even though the situation is entirely contrived by the banks to begin with.

The ironic consequence of this madness is exactly what you fear most in your last post: “unsold homes and defaulted construction loans.” This has already happened and will continue to happen because this is the ultimate end of usury: wealth concentrated in the hands of a few, while there is widespread economic distress among many- a perfect recipe for widespread default.

 

[JimG]

With respect to ends, what does the lender do when the ends change? I take out a loan to buy a home. The lender loans me the money to buy the home at no interest because housing is a basic need, as you say. (Although I still can’t figure what would impel any lender to do such a thing.)

Later, I decide to buy a different, larger, home, and then use the previous one for business purposes. Can the lender now begin charging me interest since the ends have changed? If so, I sure hope the loan docs spell that out; and I can foresee a lot of litigation about ends.

As to housing being a basic human need, how basic does it need to be to qualify for a loan at zero interest? A modest 2 bedroom bungalow? A 4 bedroom ranch? An 8 bedroom, 4-car garage home with a pool, which might be pretty basic in Santa Barbara?

And without banks, who is going to loan the money? Without banks, nobody can create money to loan, so it’s going to have to be from the accumulated savings of individuals. Perhaps we resurrect the building and loan model. Accumulate a lot of people’s savings in individual accounts, then loan it out to them to build homes.

But who’s going to deposit savings if no interest is paid to depositors? And surely if no interest is being collected from borrowers, no interest can be paid to depositors.

Now the idea of going to an all cash economy is sort of appealing to me. It means we would no longer live above our means. Prices would come tumbling down, and goods could be bought cheaply. Of course, that’s the sort of thing that gives Ben Bernanke nightmares. Deflation is his worst nightmare. Like inflation, deflation would feed on itself. Why buy anything today, since it will be cheaper tomorrow? That leads to an economic depression. During the great depression, farmers dumped crops and milk onto the ground because the prices were too low for them to live on.

As for that storehouse of food in a famine. It wouldn’t particularly affect interest rates, but it sure would affect prices of food. Food prices would rise as an inevitable way of rationing. If there’s a shortage of anything, food, transportation, ipods, prices will go up. Now, one could ration in other ways than prices, but that would cause black markets and shortages, and still people wouldn’t get any more food.

But interest is simply the price of money. Why do we allow price controls on money but not on anything else? And there is surely no shortgage of money or of credit right now in the United States. We are awash in money and credit–and in debt, and interest rates are lower than they were when my grandfather bought his first house in the 1940’s. So where’s the usury?

Maybe Aquinas and Bernanke and Obama could sit down and hash this all out. It would make the debt debate seem mild.

One final thought. Eliminating interest and going to an all cash economy might cause a great depression, but it wouldn’t do a thing to change the concentration of wealth.