Defaults of the Rich: Walking Away from the McMansions

No Fault of Mine
No Fault of Mine | Photo: Timothy Ellis /Flickr/Creative Commons License

Moneyed homeowners with huge loans are walking away from mansions in some of L.A.'s priciest neighborhoods, even if the owner can afford the mortgage payments. Who wants to be known as a "sucker and fool," one homeowner complained as he contemplated defaulting on a big mortgage based on an inflated past.

A typical case is the $4 million house - purchased around 2008 with nearly $4 million in loans - that's now worth less than $2.5 million.

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In Beverly Hills alone, according to this Reuters report, at least 180 homes in recent months have been foreclosed, scheduled for auction, or served with a notice of default.

Nationwide, foreclosures on loans over $1 million are up nearly 600 percent since 2008.

Walking away from an "underwater" real estate deal is a national trend among the more-or-less-rich who bought big at the height of the real estate bubble but whose houses are now worth far less than they owe. It's estimated that 40% of the owners who lost their house looked at their massive debt and calculated that a "strategic default" would get them out of a bad investment.

Walking away has even become something of a boast among the more-or-less wealthy - a solution with few downside risks that also marks the walker as a smart player.

That's because California is one of a small number of "non-recourse" states. Here, the mortgage lender cannot recover the full value of the loan if the homeowner defaults; the lender can only recover the house, not the owner's other assets.

The effect is producing a death spiral for loaded McMansions in some upscale neighborhoods. When owners default, they expand the inventory of over-priced houses, undercutting the value of similar homes in the neighborhood, lowering their resale value and prompting a new round of "strategic defaults" by other owners.

(For a daily dose of price chopping, go to Curbed Los Angeles where the overpriced homes of the almost rich and nearly famous are gleefully considered.)

Lest we be too amused at the troubles of the sort-of-rich, the unsold inventory of mansions they leave behind drives down property tax revenues, too, putting further pressure on city and county services.

Walking away - particularly for multi-million-dollar loans - may not be so cost-free in the future. A House subcommittee has begun work on a Federal Housing Administration bill that would establish, among other reforms, a minimum annual mortgage insurance requirement for loan recipients.

D. J. Waldie, author, historian, and as the New York Times said in 2007, "a gorgeous distiller of architectural and social history," writes about Los Angeles on KCET's SoCal Focus blog.

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