Strategic mortgage default spreads like a virus when conditions are right
When house prices are falling and it’s cheaper to rent than to own, strategic default becomes widespread, and banks are powerless to prevent it.
Lenders didn’t want borrowers to know that their friends and neighbors stopped paying their mortgages, and their lives improved. Lenders want borrowers to remain in the dark and fall victim to old beliefs and habits which prompt them to keep paying even when it is not in their best interest to do so.
Unfortunately, the quick spread of information on the Internet got out the word, and “mavens” like myself did not helping lenders out. Too bad for lenders.
A new report conducted for a mortgage-industry trade group likens “strategic default” — walking away from a mortgage you can afford to pay because you owe more than your house is worth — to a contagious disease.
It’s an interesting analogy I imagine lenders embrace. To them it is disease, but to borrowers it is medicine for their debt disease. It depends on your point of view, doesn’t it?
It’s not just the idea that strategic defaulters spawn more strategic defaulters. The report’s authors focus much of their attention on real estate experts — “mavens” — who advocate such a move and sway underwater homeowners to their way of thinking.
“Much the same way as a disease spreads throughout a population, so too do decisions to ‘strategically’ default,” the report concludes, adding: “Mavens are more contagious than non-Mavens because people place greater trust in their opinions. … In fragile markets, advice by influential Mavens can result in a flood of strategic defaults, causing a contagious downward spiral of home prices and potentially a market collapse.”
I had no idea I was so powerful. I certainly advocated strategic default for many reasons, not the least of which is that it’s very often the best thing for the families — the fact that it punishes the banks who created this mess is a bonus.
I have a hard time believing any voice, no matter how influential could really impact a housing market. People are going to do what they are going to do irrespective of what supposed experts say.
The report was sponsored for the Mortgage Bankers Association’s Research Institute for Housing America. Last year, the bankers association’s then-CEO said would-be strategic defaulters should think about the damage they would do to their neighbors’ property values and their own reputations. “What about the message they will send to their family and their kids and their friends?” John Courson told The Wall Street Journal at the end of 2009.
Let’t think about that one. What message does strategic default send to a family, kids and friends? It says I am strong enough to admit I made a mistake and change course. It says I value my families financial future more than the profits of a lender.
That just before the Mortgage Bankers Association sold its headquarters building for millions less than its 2007 purchase price — and millions less than its financing, too. The WSJ reported at the time that the association would not disclose the terms it negotiated with its lenders, but sources thought the group would be paying back only part of the $30 million that the sale price hadn’t covered. Irony lovers had a field day.
Yes, the mortgage bankers themselves strategically defaulted while simultaneously decrying their borrowers from doing the same. I guess when it is a business decision, the agreements signed in the past go out the window. What message does that say to the families, children and friends of the bankers?
People have debated the ethics and bottom-line considerations of walking away for several years now. The ethics argument boils down to whether paying your debts is a moral obligation or a contractual one (i.e. “I pay the mortgage or I give you back the house, so here’s the house, buddy”). On the financial side, there’s the chance to get out from under a house that might never be worth what you paid for it vs. the effect on credit scores, the ability to get security clearances and the possibility of future dunning attempts.
Some states are non-recourse, meaning that mortgage holders can’t come after you for the difference between what you owe and what they can sell the house for. Others — including Maryland — allow the debt collectors to come calling.
Last year I wrote about a strategic defaulter who was planning to file for bankruptcy protection after he walked away from his Baltimore home.
So, folks: What do you think of strategic default nowadays? Do you think the “disease” theory is apt?
People form strong attachments to their homes. Walking away is never a decision they take lightly. We can discuss the pros and cons and come up with our own beliefs and attitudes about it, but the turnover of our housing stock caused by the housing crash will be very painful for those who go through it.
Ruthless default or accelerated default?
There is no accepted definition of strategic default. Lenders tried to define the issue as any borrower who is capable of making a payment and chooses not to; on the surface that sounds reasonable, but that misses a very important distinction: some people chose to default because they know they can’t afford the home and they are merely choosing the timing of the inevitable.
When I think about strategic default, I think about people who chose the timing of their default when there is little reasonable hope of having equity and they are facing escalating payments. The only thing strategic about the default is the timing, not whether or not they will lose the home.
True strategic default — a default by a non-distressed homeowner who can afford the payment on a fixed-rate amortizing mortgage — is rare. In cases where the owner is severely underwater and they can rent for far less than their current payment, the incentive certainly exists, but most borrowers in that circumstance with a fixed-rate mortgage will chose to ride out the collapse. The borrowers with most incentive to default are those with toxic financing or temporary loan modifications that know they are facing an increased debt and an increasing payment. When those borrowers default on their own schedule, is their default truly strategic or merely accelerated?