Strategic Defaults Continue to Surge
According to the most recent data, more than 25% of mortgages are underwater- that is, the balance owed on the mortgage exceeds the value of the home. In the most troubled areas – such as Florida, Nevada, California, and Arizona – this figure can exceed 75%. In addition, negative equity positions can be sizable; one survey showed that the average Miami resident with an underwater mortgage owes about $75,000 more than the value of his mortgage.
In light of these statistics, it’s not surprising that more and more borrowers are simply walking away from their mortgages, despite the fact that many have the financial wherewithal to continue making payments. According to Experian, a credit rating agency, 582,000 such borrowers executed a “strategic foreclosure” in 2008 alone, which is more than twice as high as the 2007 total.
In other words, a growing contingent of borrowers has determined that it’s simply not economical to continue paying their mortgages. (As an aside, this is an excellent indication that homeowners, themselves, don’t have much confidence in the apparent housing recovery that many analysts believe is taking shape). Before, it was assumed that the impact of foreclosure on one’s credit would be enough to discourage strategic default, but the uptick in this trend demonstrates otherwise. Some borrowers evidently think it will be too many years before housing prices will return to the bubble levels. For those that bought properties for speculative purposes, there is a sense that it makes little sense to continue making payments on an investment that has little value.
Despite the clearly negative impact of this phenomenon for lenders, they appear to be doing little to avert it. Some are finally helping borrowers with loan modifications, but this rarely involves a truncation of the principal amount. Thus, borrowers who were underwater before receiving a modification will likely remain underwater after a modification, despite the lower monthly payment.
The government, for its part, hasn’t done much either. Its program aimed at helping underwater borrowers reduce their debt burdens through refinancing has been a miserable failure, reaching only 3% of eligible borrowers, despite the recent elimination of an initial 5% cap on underwater equity. It seems that despite the possibility of a lower interest rates, most borrowers are smart enough to realize that paying money (i.e. closing costs associated with the refinancing) to retain an underwater mortgage doesn’t make financial sense. Ironically, the Mortgage Forgiveness Debt Relief Act of 2007 is facilitating strategic default by allowing borrowers to discharge of debt tax-free. [If not for the law's passage, foreclosure could have potential tax consequences].
Still, there are negative consequences of ignoring government help and deliberately defaulting on a mortgage. For the majority of Americans, foreclosure is still stigmatized. From a financial standpoint, foreclosure (as well as short sales and deeds in lieu of foreclosure) will immediately result in a lower credit rating, diminished ability to borrow, and higher interest rates. Thanks to the Mortgage Forgiveness Debt Relief Act, strategic default no longer carries any tax implications. Of course, they may be costs associated with finding a new residence.
From a legal perspective, one’s liability post-foreclosure depends one’s state of residence. 10 states forbid banks from making claims against personal assets when foreclosing on a mortgage with negative equity. The other states, however, generally allow lenders to sue for the difference. Legal experts have indicated, however, that this is only used in 15% of cases, which means the majority of defaulters get off with hardly a slap on the wrist. Still, if you’re considering this as an option, it would be beneficial to consult a lawyer and/or accountant just to confirm.