Mortgage, Car Loan, Credit Card: Pay Any Two

Imagine that you are in financial distress. You have a mortgage, a car loan, and credit cards, but cannot pay all three. Which gets paid and which gets stiffed?

Obviously, this is a lesser of evils situation, not an ideal one. Not paying any one of them will have negative consequences. Defaulting on the credit cards  will likely result in not being able to use them to buy more stuff. And the otherChicklet-currency two loans are secured, so not paying those bills could result in the loss of your wheels or roof over your head.

You might think that since shelter is so important, the mortgage would be the most likely bill to be paid. And since buying more stuff on the credit cards is less vital to a person in financial trouble, you might assume that credit cards would be the most likely to be defaulted on. Having your cards taken from you would suck, but not as much as having your car taken.

Not so. Last week Wallet Pop ran a post by Lita Epstein that looked at default data for these three types of loan. Credit cards do turn out to be more commonly defaulted on than car loans, but not by as much as you might have assumed. 1.1% of credit cards were 90 days delinquent in the third quarter. 0.81% of car loans were 60 days delinquent.

But way out in front in the delinquency derby are mortgages. According to TransUnion, in the third quarter of last year 6.25% of US mortgages were 60 days delinquent.

That is a big number and one that is, to say the least, counterintuitive. Isn’t losing the house the worst case scenario for most people? Wouldn’t you want to protect your home by paying the mortgage before you paid the other bills?

Yes and no. As I have argued here, the visceral preference that many people have for paying secured debt first is not, on close examination, as reasonable as it sounds. If nothing else, the interest rates on credit cards and car loans are generally much higher than those on mortgages, so paying them first could be saving the most money.

Then there is the ever-popular topic of strategic default. This is sometimes referred to as homeowners "just walking away" and was for a time called "jingle mail" because the homeowner would (figuratively) mail in the keys to the house. But on reflection it should be clear that this is not what strategic defaulters actually do.

Suppose you owe $400K on a house worth $300K in a non-recourse state and you can’t pay your bills. Do you sign the house over to the bank and move out? Of course not. You just stop paying the mortgage. Eventually the bank will foreclose, but by the time the sheriff shows up to evict you you will have had many months, maybe even a year, of rent-free living.

Needless to say, mortgage delinquency rates are highest in states suffering the worst declines in house prices, that is, the ones with the highest proportion of underwater houses. A staggering 14.53% of Nevada mortgages are delinquent.

So paying credit cards and car loans before mortgages could be the shrewd move after all. How did millions of households cleverly determine that this non-obvious strategy was the best course? I think the truth is that they didn’t.

As the Wallet Pop post discusses, not paying a car loan or a credit card has more obvious and immediate consequences than not paying a mortgage. Stop making your car payments and it will be repossessed. And credit cards may be as important to the American lifestyle as cars. Consumers reason that as long as they keep making the relatively modest minimum payments they will be able to keep using them. The fact that the card company is likely to close an account once they discover that the borrower has stopped making his mortgage payments may not occur to that many people.

Still, not paying the mortgage may be the right answer, even for the wrong reasons.

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