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Walking Away: The Impact on Housing

There is a growing trend in this country of people walking away from their mortgage obligations. The definition of a ‘walk away’ borrower is one who has the financial means to continue to make their mortgage payment but decides not to. This situation is also called strategic default.

The incidence of people taking this path is growing dramatically. A study done by The Chicago Booth/Kellogg School Financial Trust Index reported:

The number of homeowners willing to default when the value of a mortgage exceeds the value of their house, even if they can afford to pay their mortgage, dramatically increased compared to just a year ago. The percentage of foreclosures that were perceived to be strategic was 31 percent in March 2010, compared to 22 percent in March 2009.

In a news release announcing the report Paola Sapienza, professor of finance at the Kellogg School of Management at Northwestern University and co-author of the report said:

“With more and more homeowners believing that lenders are failing to pursue those who default on their mortgages, there is a risk that a growing number of homeowners will walk away from their homes even if they can afford monthly payments.”

Strategically defaulting on your mortgage has been supported by many main stream players such as a law professor at the University of Arizona, the New York Times and the Wall Street Journal which said in a blog post that:

Whether we like it or not, walking away from debts is as American as apple pie.

What impact does this have on the housing market?

PRICES

House prices are determined by supply and demand. The supply of distressed (discounted) properties lowers the values of all the homes in the area. These foreclosures are added to the mix of comparables used by appraisers to establish value on homes sold. If a  borrower decided to short sale instead of walk away, the property would sell for approximately 86.9% of full value while a foreclosure sells for only 57.3% of full value (according to First American Core Logic’s Distressed Property Report).

Freddie Mac in a news release probably said it best:

Let’s start with the neighbors. When strategic defaults occur, homes go into foreclosure and sit vacant for some period of time. We know from experience that foreclosures and vacancies drive down the property values of everyone else in the neighborhood. Thus, strategic defaulters, in effect, deplete the personal wealth of their neighbors. Get a critical mass of strategic defaults, and broader communities and regions become affected. Indeed, Economy.com, the analytic firm, recently said that more strategic defaults could tip a fragile housing market back into one of further price declines. Even more families harmed.

As prices fall, more borrowers fall into a position of negative equity (their house is worth less than the mortgage). This is the number one reason people ‘walk away’.

This past week a Seeking Alpha article entitled Housing: Could Strategic Default Turn into a Full Blown Movement? reported:

Many homeowners are unlikely to sit idly by while their neighbors walk away from their underwater mortgages. But one thing is certain: if strategic default becomes a widespread trend then a double dip in housing prices has moved a lot closer to becoming a done deal.

LENDING GUIDELINES

Banks are trying to deal with this new phenomenon of ‘walking away’. No one could blame them if they started to price into mortgages the risk to which they are now being subjected.  

Freddie Mac, in the same news release mentioned above, discusses this exact point:

Should strategic defaults become more common, mortgage guarantors and investors, including Freddie Mac, would need to factor this risk more prominently into their credit policies and prices. The likely impact on future homebuyers: the cost of a mortgage will go up and credit terms will be less flexible. Thus, the impact of strategic defaulters on still more families might be more expensive mortgages and loans that are more difficult to obtain. The strategic defaulter does not usually consider these costs.

What does this mean to you?

The value of your home is being adversely impacted by those that walk away. The cost of your next mortgage may also be affected.


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  1. […] can find information on the impact defaults have on surrounding homeowners here. Share var a2a_config = a2a_config || {}; a2a_config.linkname="A Conversation on Short Sales […]

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