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Will Falling Prices Create Wave of Strategic Defaults?

Strategic default:  when a borrower defaults on their mortgage even though they have the financial ability to repay it. 

Strategic defaults lead to foreclosures. It is important to realize that an increase in the number of foreclosures will dramatically impact any possible housing recovery. A loss of income or an increase in negative equity (where the house is worth less than the mortgage on the house) are the two main reasons that will cause a homeowner to strategically default.

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.

Are strategic defaults about to skyrocket?

This week, Clear Capital sent out a special release where they reported:

This special Clear Capital Home Data Index (HDI) alert shows that national home prices have declined 5.9% in just two months … This significant drop in prices, in advance of the typical winter housing market slowdowns, paints an ominous picture.

The reason this caught our attention is that the 5.9% equated with a number we recently read on strategic defaults. CoreLogic in their most recent Negative Equity Report stated:

11 million, or 23 percent, of all residential properties with mortgages were in negative equity at the end of the second quarter of 2010 … An additional 2.4 million borrowers had less than five percent equity.

Almost two and a half million homes were within 5% of negative equity and prices just fell over 5%. Strategic defaults may soar! The CoreLogic report quotes Mark Fleming, their chief economist:

“Negative equity continues to both drive foreclosures and impede the housing market recovery. With nearly 5 million borrowers currently in severe negative equity, defaults will remain at a high level for an extended period of time.”

What about the ethical responsibility to pay our debts?

As the housing crisis has savaged more and more families, there seems to be a growing number of people who now see strategic default as acceptable. According to a recent Pew Research Center survey:

More than a third (36%) say the practice of “walking away” from a home mortgage is acceptable, at least under certain circumstances … two-in-ten (19%) say it’s acceptable and an additional 17% volunteer that it depends on the circumstances.

Bottom Line:

There will be more strategic defaults as prices fall. That will mean more foreclosures which will cause prices to fall leading to more homes in negative equity. An increase in negative equity will create more strategic defaults which will cause…

That is the vicious cycle we must break.

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3 replies
  1. John
    John says:

    This is a pretty dark picture of our future, maybe I have my head in the sand but I don’t see this endless spiral into the abyss. The American lifestyle centered with a comfortable house, is just too good to give up. We are a resourceful people, and Realtors are especially, we will get this behind us. It will not be easy but we will make the sacrifices nessesary.

  2. Bob Pace
    Bob Pace says:

    As a realtor we must “Walk out of the forest so we can see the Trees”
    There was and still is too much debt against real estate because of the false values that were put on them. As Foreclosures,Strategic Defaults,Short Sales and whatever continue we will have some affordability brought back to the market . We will ride this out!
    OH Yeah less taxes and more jobs would help

  3. Mark Brian
    Mark Brian says:

    Housing needs the economy to recover but the economy needs housing to recover. Kind of like the chicken or the egg. But in this case, many people are being hurt.

    Throw the stories about the banks possibly cutting corners on foreclosures into the mix, and it just gives some people the justification they are looking for to walk away.


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