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Strategic Default: 32% Believe it’s OK

A recent survey by JZ Analytics revealed that a growing number of Americans feel homeowners should be able to strategically default on mortgages. A strategic default is when a homeowner, who has the financial resources to continue making their mortgage payment, instead decides to walk away and let the house go to foreclosure. In many cases, the house is worth less than is owed on the mortgage

Some responding to the survey “believe the mortgage market has been a scam for many years, built on false promises that took advantage of people that didn’t understand what was happening and they never had a chance of paying the mortgage off”.

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Will Strategic Defaults Be the Next Challenge to Housing?

Strategic defaults may be the next challenge to a housing recovery. Investopedia defines ‘strategic default’:

“A deliberate default by a borrower. As the name implies, a strategic default is done as a financial strategy and not involuntarily. Strategic defaults are commonly employed by mortgage holders of residential and commercial property who have analyzed the costs and benefits of defaulting rather than continuing to make payments and found it more beneficial to default.”

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One Thing That Still Concerns Us

There is no doubt that the housing market is stumbling to a recovery. This past week Lawrence Yun, NAR’s chief economist, predicted a 4% increase in sales next year. Last month, Celia Chen of Moody’s Analytics projected sales to increase over 20% in 2012. Any increase in transactions will be welcomed.

However, we believe there is one headwind that could jeopardize a recovery: fragile consumer confidence. Consumer sentiment, as measured by the University of Michigan, has seen modest improvement in the last few months after nose diving over the previous several months. Moving forward, any hit to consumer confidence will impact a real estate rebound.

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Will Falling Values Lead to More Strategic Defaults?

As prices continue to soften, more and more homeowners will fall into a position of negative equity on their homes. This means that the balance on their mortgage is greater than the value of their home. The reason this is important is that people are more prone to strategically default on their mortgage when ‘underwater’.

What is a strategic default?

Let’s first define strategic default in simple terms. According to Wikipedia:

A strategic default is the decision by a borrower to stop making payments (i.e. default) on a debt despite having the financial ability to make the payments.

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Negative Equity: Not Good But Improving

Back in October, we posted that falling home prices would drive more homeowners into a negative equity situation where their home was worth less than the amount of their mortgage (also known as the house being ‘under water’ or ‘upside down’). If a homeowner falls further into negative equity, it increases the chances that they will walk away from their mortgage obligation. This is known in the industry as a strategic default. This could dramatically increase the number of foreclosures coming to market and cause house values to fall further.

The Wall Street Journal reported on the impact of negative equity on strategic default:

Most defaults are typically driven by a combination of income shock and negative equity, or what’s known as the “double-trigger” hypothesis. While borrowers who lose their jobs but have equity in their homes can sell and avoid default, those without any equity are left with fewer options.

The most recent Fannie Mae National Housing Survey looked at how people viewed walking away from their mortgage obligation. Here are some of their findings:

  • Underwater delinquent borrowers are the most likely to have considered stopping their mortgage payments.
  • Delinquent borrowers are almost three times as likely to have considered stopping their mortgage payments if they know someone who has defaulted on their mortgage.
  • 17% of all people who are delinquent believe the amount they owe on their mortgage is 5-20% more than the value of their home. That number jumps to 29% when they believe the amount they owe on their mortgage is at least 20% more than the value of their home.
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