More Homeowners Opt for ‘Strategic Default’

Strategic defaults, the practice of homeowners defaulting on their mortgage even though they have the financial capability to make the payments, is on the rise.

The primary reason is the increasing number of underwater home loans — mortgages that have a higher balance than the property is worth in today’s market. Also, another key motivator is the continuing unemployment problem.

Falling home prices, the possibility of a long-term underwater home loan and advice from certain influencers, may have encouraged others to simply stop paying on their home mortgage. This may have deleterious consequences in some markets, according to a study by the Mortgage Bankers Association.

“Recently, the overwhelming media coverage of the current financial crisis has made homeowners aware — or at least alerted them to become aware — of their equity position in their home,” said Michael Seiler who headed the study for MBA.

“While the merits of such a choice can and will continue to be debated, what is indisputable is that the possibility to strategically default has certainly been brought to the attention of current homeowners like never before, with potentially negative consequences for housing markets,” said Seiler.

Making the decision to strategically default on a home mortgage can have serious consequences. Certain legal effects are determined by the state in which you reside. Different states treat defaults on mortgage debt differently. Most notably distinguishing whether it is recourse debt or non-recourse debt, meaning whether the mortgage lender can pursue claims against the defaulted debtor or not.

Also, mortgage refinancing may be treated differently from an original, un-refinanced mortgage, and mortgages on second homes may be treated differently from mortgages on primary residences.

The temptation to strategically default is often very powerful. After deciding not to make payments any more, the borrower can live (free of the costs of payment or rent) until the lender forecloses, which may take from several months to a year. A borrower may use this time to pay off or negotiate other debt.

However, it should be noted that foreclosure of the borrower’s house will result in a negative entry on the borrower’s credit rating. In the future, it could make obtaining loans more difficult or more expensive for the borrower.

With otherwise good credit, a new mortgage from U.S. government agencies will be denied until 3 to 7 years have passed since the actual date of foreclosure.

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