Rising home values halted strategic default
Just as buying a home is an emotional decision, defaulting on the mortgage and giving up a home is too. Any borrower who is deeply underwater and making payments in excess of a comparable rental would benefit financially from strategic default. That’s the math. However, defying the logic, very few loanowners are actually defaulting. People cloak their reasons with intellectual rationalizations, but it’s an emotional decision based on the desire to keep their family home and the ethical considerations that go along with the decision. As with any emotional decision, it may be right, or it may be wrong depending more upon the perceptions of the decision maker rather than some outside measuring stick.
Since this is an emotional decision, anything pertinent to the decision maker will have a profound impact on the number of people who actually decide to strategically default. Most people default because they can no longer take the emotional strain of trying to make payments they really can’t afford. Their willingness to endure this hardship is strongly impacted by what they perceive as the reward. Many potential strategic defaulters don’t because they cannot endure the loss of self respect that would go along with what they interpret as breaking a promise. Many others believe losing the family home would inflict more pain on themselves and their families than continuing to make the payments. For many, the additive impact of both of these factors compel them to endure the financial distress rather than seek the strategic default exit.
Another major weight on the decision-making scale is the perception of future financial reward. People bought houses during the housing bubble because they believed they would be rewarded with HELOC money or increasing value in their properties. The housing bust squelched most of these dreams, but hope springs eternal, and many are holding on with the belief the market will eventually make them whole again. The belief in this future reward can push a borrower in either direction depending on what’s happening with home prices. As home prices plummeted, so did borrower’s hopes of ever having equity again. Borrowers without hope of equity often strategically default. If it becomes a widespread perception that house prices are on the mend, the psychological impact on loanowners will be profound. Many who still may not have equity in many, many years will at least see the light at the end of the tunnel. Rising home prices give loanowners hope, and this hope will dramatically change the strategic default equation. In 2013, strategic default will become far less common.
71 Percent of Surveyed Economists Would Not Strategically Default, According to June 2012 Zillow Home Price Expectations Survey
SEATTLE, July 26, 2012 /PRNewswire via COMTEX/
If faced with a deeply underwater mortgage, most economists and homeowners agree they would not strategically default, according to dual surveys from Zillow®.
Nearly three-quarters of economists surveyed in the June 2012 Zillow Home Price Expectations Survey (71 percent) said they would not strategically default, even if they owed on their mortgage at least 40 percent more than the current value of their home.
The survey, sponsored by leading real estate information marketplace Zillow, Inc. and conducted by Pulsenomics LLC, was compiled from 114 responses from a diverse group of economists, real estate experts and investment and market strategists. The main portion of the survey, which captures respondents’ expectations concerning the future of home prices, was released last month.
In a separate Zillow survey conducted by Ipsos®, 59 percent of homeowners said they would not make the decision to strategically default if they were underwater on their home by more than 40 percent[i]. Nearly 75 percent of homeowners in the U.S. with an underwater mortgage are underwater by 40 percent or more, according to Zillow’s first quarter Negative Equity Report[ii].
That also says that 41% of loanowners would strategically default. That is a very high number.
“We were initially surprised that so few economists would be willing to strategically default, since when you do the math, it can often be the best economic choice, if you leave aside moral and ethical considerations,” said Zillow Chief Economist Stan Humphries. “Of course, strategic default is not just a mathematical decision. The most common reason for avoiding strategic default cited by homeowners was that it is a moral issue. That likely comes into play with economists and analysts, as well.”
Thirty-seven percent of homeowners who said they would not strategically default cited moral reasons, while 35 percent indicated it didn’t make sense given that they intended to live in their current home for a long time.
The “live in the house for a long time” response is the same as saying they expect to own long enough to have equity again. There is an embedded believe in a return to appreciation.
The Zillow Home Price Expectation Survey additionally asked the same group of economists and housing analysts their stance on the adoption of government-sponsored mortgage principal forgiveness initiatives for underwater borrowers. The survey found that 72 percent of respondents opposed any adoption of such programs, while 28 percent were in favor.
I am pleasantly surprised to see that 72% of Americans do not want to see their irresponsible brethren given free money. The other 28% are likely those who would receive the bailouts.
“These survey results suggest that economic and financial considerations are not the dominant drivers of behavior for even deeply underwater borrowers,” said Pulsenomics Founder Terry Loebs. “This underscores the challenges in valuing underwater mortgages and in determining the costs and benefits of principal forgiveness initiatives.”
To be coldly calculating about it, it makes no sense to forgive principal or reduce interest rates for that matter on underwater loanowners. Most of them simply won’t strategically default even if it’s the best financial decision. They are making an emotional decision, and what they really need is hope of a brighter future. Once they have that, they will hang on forever if necessary. It’s not logical, but it is how loanowners think. I fully expect to see strategic default decline considerably once the general public accepts the idea we are at the bottom of home prices — whether we really are or not.