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 other 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.

Cars, Credit Cards, Housing | Frank Curmudgeon | January 26, 2010 12:59 pm

199 Comments

By steve, January 26, 2010 @ 2:22 pm

For people living paycheck to paycheck, a job loss can devastate their ability to pay the mortgage. The working class don’t often have significant savings that can sustain the drop in income. As a result, the first priorities are food and utility bill payments to keep the lights and heat on. Next in consideration are your three categories.

Even if you carry large balances, credit card interest only payments aren’t that large. If you keep paying those minimum payments, you can sustain yourself for a bit during unemployment. A car is necessary for your livelihood. Given that mortgage payments are so big, its no wonder that desperate people choose the car and credit card payments over the house. No one wants to be forced to choose, but I can see why mortgages lose out to credit cards (which can pay for food) and cars (which you can sleep in after foreclosure and are critical in America for transportation).
By Jim, January 26, 2010 @ 2:36 pm

I would guess that people may default on their mortgages more than smaller debts because they simply can’t afford the mortgage payment and/or because the amount of debt with a mortgage seems too overwhelming to them.

Say I have a car loan and a mortgage. The car loan is $300 a month and the mortgage is $1500 a month. I’m mostly getting by making $45k a year. I have negligible savings. Then I lose my job and I’m getting $400 a month in unemployment. Theres no way I can pay that mortgage. Plus I owe $230k on that house and its now only worth $175k. THe car however I bought 2 years ago new and its now worth $7k and I owe $9k still. I simply can’t afford that mortgage but I can still afford my car payment. Plus that house loan is $230k which is a very big number while I owe only $9k on the car which is a much smaller number. I’m scared by that $230k of debt but not as worried about $9k debt.

Why people would pay credit cards before mortgage and car loans is more puzzling. It might be because they are still using the cards to subsidize their spending even though they are insolvent and spending more than they earn. It seems that people will continue to over spend until they are stopped in some way. So if I’m making $45k and spending $55k then I’ll continue to do that until the credit runs out. In order to keep the credit from running out I have to keep making my minimum payments.

Maybe credit card and car loans are written off faster than mortgages. I assume it would take a while for someone to go from default to being actually evicted in foreclosure. I’m guessing 6-12 months from the day you miss a mortgage to the day the bank officially takes ownership and you’re officially foreclosed. So that whole time you may show on the books as being in default status. But with a credit card or car loan they may move more swiftly from default to written off or car repossession. I’m not sure on that but its a theory.
By Jim, January 26, 2010 @ 2:37 pm

Looks like Steve had the same thoughts I did but I was very slow in typing mine.
By Jim, January 26, 2010 @ 2:38 pm

“I’m getting $400 a month” I should have said $400 a week to be more realistic. But thats just made up example anyway so who cares. OK I’ll stop posting now..
By Kosmo @ The Casual Observer, January 26, 2010 @ 5:45 pm

If you can manage to avoid eventual foreclosure, putting money toward the mortgage also makes sense as a bankruptcy asset shelter
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