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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.

This is particularly associated with residential and commercial mortgages, in which case it usually occurs after a substantial drop in the house’s price such that the debt owed is (considerably) greater than the value of the property – the property negative equity or “underwater” – and is expected to remain so for the foreseeable future, such as following the bursting of a real estate bubble. Such borrowers are called “walkaways.”

This definition itself serves as the explanation as to why people will default.

How do Americans view strategic default?

In Fannie Mae‘s recent National Housing Survey, they shed some light on American’s thoughts on strategic default.

  • The number of underwater homeowners who believe it is okay to default on your mortgage if you are under financial distress has almost doubled in the last twelve months (14% to 27%).
  • 47% of people that are underwater and behind on their mortgage have considered strategic default.
  • Those who know a strategic defaulter are more likely to have considered defaulting.
  • 1 in 5 Americans knows a strategic defaulter

Bottom Line

As more people enter into negative equity, more will be tempted to ‘walk away’ from their mortgage obligations. If they do walk, that will increase the number of homes entering foreclosure.


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7 replies
  1. Sean Carpenter
    Sean Carpenter says:

    Great post – I find it very sad that 1 out of 4 people now feel it is okay to “walk away” from an obligation that they agreed to. I guess it should come as a surprise with almost 50% of new marriages ending in divorce these days but there are a lot more factors which influence that. The interesting part about a strategic default is that these people could pay their mortgage if they wanted to. Until the penalties are truly “penal,” this will continue and affect the other 73% who feel that the rules are the rules.

    Reply
  2. Brian O'Dea
    Brian O'Dea says:

    A “Strategic Defaulter” is not someone who is underwater and facing financial hardship..
    I quote the above post…”The number of underwater homeowners who believe it is okay to default on your mortgage if you are under financial distress has almost doubled in the last twelve months (14% to 27%).”

    Reply
  3. RJ Avery
    RJ Avery says:

    I have dealt with these customers and honestly I don’t find it shocking that the number of people willing to default has doubled. IMO it will continue to go up. The more the public begins to understand the criminal activities that went on that lead to the build up in an over valued inventory.

    The easy access to mass sources of cash without the lender vetting the clients is their own decision. However processing those loans into securities and placing in AAA rated investments is and was criminal. To me we should be arresting the regulators, politicians and bankers that allowed this type of wild west financing to ever happen. And next time as Realtors and Loan Officers we should advise our clients against over indulgence or buying homes that are too much with tricky financing that is based on making more money in the future… Its not responsible or sustainable..

    A strategic default to me is someone who can afford and does not want to pay for the home they paid for… Well thats just wrong?? To me not so much… When you have homes that have dropped 20 30 or 40k in value in less than 3 years because a large number of your neighbors not only vacated but trashed homes around you a strategic default IMO is a complete choice of the borrower and honestly there was no moral or ethical responsibility shown by lenders when giving out the responsibility of home ownership. Why then should a borrower feel loyalty to the bank?

    Also a lot of people could have paid their loans if they would have got in and lowered payments, extended payment schedules and just worked with people. I think a bank makes enough money off of a 30 year mortgage and could have afforded to head off the issue with some fore sight… Oh but wait these are the same yahoos are the ones that got us here…

    Forney Tx Real Estate

    Reply

Trackbacks & Pingbacks

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