Strategic Defaults

Strategic defaults may be the next challenge to a housing recovery. Investopedia defines ‘strategic default’:

“A deliberate default by a borrower. As the name implies, a strategic default is done as a financial strategy and not involuntarily. Strategic defaults are commonly employed by mortgage holders of residential and commercial property who have analyzed the costs and benefits of defaulting rather than continuing to make payments and found it more beneficial to default.”

A new foreclosure is created every time a seller voluntarily decides to stop making their mortgage payment. Obviously, an increase in foreclosures puts downward pressure on the values of other homes in the community. We believe there are several reasons this could be another headwind to any recovery in housing.

There Are 11.4 Million Homes in Negative Equity

According to CoreLogic’s most recent Negative Equity Report, there are over 11.4 million homes where the value of the home is less than the value of the mortgage(s) on that home, a situation know as negative equity or being ‘underwater’.

Negative Equity Is the Primary Reason Baby Boomers Default

According to a survey by web site You Walk Away, 68% of baby boomers who walked away from their homes (strategic default) listed ‘property value’ as the main reason. 88% of the defaulters did not access any of their retirement savings before walking away and 97% would advise family members in the same predicament to also default.

The Moral Objection to Not Default is Diminishing

In the past, homeowners felt a moral obligation to repay their debts. That is beginning to change. Dr. Andrew Jennings, chief analytics officer at FICOexplains:

“After five years of a brutal housing market, many people now view their homes more objectively and with less sentimentality. Regardless of legal or ethical issues around strategic defaults, lenders must account for this risk when they evaluate mortgage applications in declining markets. Many homeowners who find themselves upside down on mortgages in the future are likely to consider strategic default as an acceptable exit strategy.”

Prices Could Soften Again Over the Next 6 Months

As we reported Monday, many experts feel that prices might falter again before they finally stabilize in 2013. Every time prices fall more homes fall deeper into negative equity. The CoreLogic report mentioned above also states that 2.3 million homes had less than 5 percent equity, referred to as near-negative equity.

We will continue to keep our fingers on the pulse of this issue to monitor whether or not it begins to slow the momentum the housing recovery is currently experiencing.