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Conventional Thinking About Strategic Defaults May be Wrong
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- Kara Johnson | May 25, 2010
Why do homeowners choose to deliberately default on a mortgage? The common wisdom is that it’s a purely calculated choice, made by carefully weighing the financial pros and cons. But much of that common wisdom is wrong, according to the person who put the spotlight on so-called “strategic defaults” in the first place.
University of Arizona law professor Brent White earned a lot of notoriety last year when he suggested that many homeowners in underwater mortgages would be better off to just stop making payments and allow their homes to go into foreclosure. Now, he’s back with another report that sheds new light on why people default – and suggests a different approach to preventing foreclosures.
White, like many people, assumed that when people choose to strategically default, they do so because of the financial benefits – they basically decide to stop throwing good money after bad by continuing to make mortgage payments on a home that has lost much of its value.
An emotional, not just financial, decision
He was surprised to discover then, that rather than being a calculated decision, strategic defaults are often an emotional one – that homeowners who voluntarily choose to stop making mortgage payments are motivated by anger, fear and frustration – and not just the financial aspects of their situation.
“Negative equity alone does not drive many strategic defaulters’ decisions to intentionally stop paying their mortgages,” White wrote. “Rather, their decisions to default are driven primarily by emotion – typically anxiety and hopelessness about their financial futures and anger at their lenders’ and the government’s unwillingness to help.”
White suggested that to stem the tide of strategic defaults, the government and mortgage companies need to take steps to address these emotions. In fact, he suggests that principal reductions, which many consumer advocates have called for, are not as important as simply helping borrowers feel they are not throwing their money away.
Strategic defaults more likely to be ideal customers
White’s report, Take This House and Shove It: The Emotional Drivers of Strategic Default, is based on an analysis of more than 350 case histories of self-identified strategic defaulters. Among his more surprising findings: borrowers who choose to strategically default tend to be what many lenders would regard as ideal customers – older, better educated and with high credit scores before choosing to default.
That runs counter to a common perception of strategic defaulters as people who don’t appreciate the value of good credit or who are morally suspect. In fact, White says their good credit and payment history is often a factor in why people choose to default – they’re angry when their lenders refuse to work with them despite the long histories as excellent customers.
“I’m the prime, perfect example of who should be helped,” one borrower wrote to White. “I’ve never missed any payments in my historical credit life span (I’m 30) and my score is 750 middle fico. That said, where has it gotten me? I’d rather have hundreds of thousands of $ than a high credit score...”
Future finances a concern for many
Generally, a strategic default is considered to be when someone decides to stop paying their mortgage even when they could still manage the payments. What happened with many of the borrowers he studied, was that while they could still make their monthly mortgage payment, if need be, other financial issues were pressing on them as well.
Many were counting on at least being able to recover what they originally paid for their homes; to continue making payments on a home that had lost over $100,000 in value (typical for the group) and seemed unlikely to ever gain it back would be a financial disaster for them.
White said every single one of the 356 borrowers in his study contacted their lenders in an effort to work something out before defaulting. He said they were frustrated by the fact that their lenders would not consider them for loan modifications as long as they were still current on their mortgages, even though many had suffered financial setbacks such as a job loss by one or both earners in the home, which fed their anger and frustration.
Those who chose to default often felt shame from their decision, and were sometimes ostracized by former neighbors who had kept their homes. White noted studies that showed that 7 out of 10 homeowners who had defaulted on their mortgages still believed it was wrong to deliberately default on an underwater loan, only a bit lower than the roughly 85 percent of all homeowners who feel that way, according to a Fannie Mae study.
Need for financial reassurance
White suggests that the way to prevent homeowners from deliberately defaulting is to offer some reassurance that they are not jeopardizing their financial futures by continuing to make mortgage payments. One possibility he suggests would be reducing monthly payments to the equivalent of the rent on a comparable home in the same area, so the borrower would feel they are still getting good value for their money.
He suggests that lenders may be better off taking a small loss on such adjustments over time than simply allowing the loans to default and taking a big loss all at once. In addition, he suggests that stemming a potential tide of strategic defaults would help support home values in general, further helping to prevent additional losses.
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National Rates
| Loan Type | Today | +/- |
|---|---|---|
| 30 yr fixed | 3.80 |
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| 15 yr fixed | 3.10 |
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| 5/1 ARM | 2.73 |
|
Rates may contain points
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