There is a distinct difference between losing ones home to foreclosure due to an inability to meet the mortgage payments, and simply walking away when the payments are still affordable. There is a rising tide of borrowers now engaging in strategic default, who stop making their mortgage payments and remain living in their home without paying, until the bank legally forecloses on the property. Although the mortgage payments remain affordable these homeowners consider they are just throwing money away servicing a mortgage which is in excess of the value of their property and certain trends are encouraging this attitude.
There are currently around 25% of all residential mortgages ‘underwater’, with properties having sizeable negative equity which could take as long as the lifetime of the mortgage to recover in some instances. Homeowners are frequently paying double the costs of renting a comparable property in mortgage payments. The way in which state laws allow for strategic defaulters to walk away with little financial pain makes the practice easy to follow, when combined with a shift in moral values which make it more socially acceptable to do so.
Those who do strategically default lose their homes, and their credit score suffers. Borrowers in many cases live in ‘non recourse’ states, where the lender is not allowed to pursue the borrower for the difference between the amount raised in a bank sale of the property and the outstanding mortgage balance. Each state has different rules pertaining to pursuing this balance which can be granted by means of a deficiency judgment.
Some states allow the lender to seize assets of those who strategically default, whilst others don’t. Most states allow for deficiency judgments against those with second mortgages. It has been rare for lenders to previously pursue borrowers through costly deficiency judgments but this is likely to change now so many are deliberately defaulting. Of course those who have already overcome the moral call of abandoning their debt through strategic default will most likely see no further shame in filing for Chapter 7 bankruptcy which will squash any deficiency judgement.
Strategic defaults have become more acceptable since Brent White, a law professor at the University of Arizona, published a paper encouraging more people to consider it as a rational financial judgment. He highlighted the two main reasons why borrowers were reluctant to do so as 1) “the desire to avoid the shame and guilt of foreclosure; and 2) an exaggerated anxiety over foreclosure’s perceived consequences.”
Yet as more people engage in the conscious decision to walk away from their debt it has a knock on effect and more people follow. The consequence of course is that houses within an area then lose even more of their value, influencing yet more with negative equity to do the same. The stigma disappears when it becomes common practice.
A poll conducted by the Chicago Tribune found that half of those questioned thought it “was acceptable for an individual to intentionally walk away from a mortgage they could afford to pay.” The mortgage is seen as bad long-term investment which was issued by bankers who were willing to over appraise the property value in before issuing the mortgage.
Those who do consider it should familiarize themselves with their state statutes and codes, and take legal advice over the possible consequences. Naturally as well there are companies springing up which are encouraging borrowers to strategically default and helping them to do so, for a price. The logical conclusion will be a rising costs for those seeking mortgages in the future, including those who are willing to rent for the period in which their voluntary foreclosure impacts on their ability to purchse property again.
Sources: Chicago Tribune
NY Times