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Strategic Defaults

Posted on August 16 By Justin McHood

A new term has cropped up to describe people who could afford to stay in their home, but choose to just walk away. The term that the media has put on this is Strategic Default.

The foreclosure crisis has left no part of the country untouched, but in many of the "sand states" of California, Nevada, Arizona and Florida - foreclosures are more common than in other places. In Las Vegas, for example, it is estimated that 80% of all homeowners who bought their home between 2005 and 2007 have negative equity - where the homeowner owes more to the lender than he could sell his home for.

In an article by the Las Vegas Sun, it highlights some of the common reasons that people simply choose to walk away and become a strategic default statistic including:

  • People who know someone who defaulted are 82 percent more likely to declare their intention to do so.
  • No households would default if their equity shortfall were less than 10 percent of the value of their home but “Once the numbers become a bigger percentage of the value, the temptation is much greater,” Zingales declared. “If there are a lot of people negative, there is a very high risk. Our study shows there is a highly contagious effect.”
  • The social stigma of default lessens if others are doing it around them. Once foreclosure had a negative stigma attached to it, now it is more common.
But not everyone agrees that strategic defaults will become a major problem:

Shari Olefson, author of “Foreclosure Nation: Mortgaging the American Dream,” said she thinks the number of people who walk away will be limited because she doesn’t expect prices to fall much further.

Besides, it’s complicated for families because they have to find a new home and put their children in a new school, she said. Others will be unwilling to take a hit on their credit that could affect them for three to five years if they try to buy a new home or new car. It would affect their ability to get loans, and interest payments would be higher.

Olefson said she is concerned, however, that over time some will become fatigued with their home values and get more comfortable with the thought of walking away from their mortgages. Many are waiting to get loan modifications, but if that doesn’t happen, they are vulnerable.

Olefson said the decision to walk away is a conversation people should have with their pastor rather than their financial adviser. She said she considers it wrong for them to pursue walking away even though she understands people are angry when their neighbors go through the foreclosure process and that brings down others’ home values. It’s easy to make excuses because Wall Street contributed to the problem, she said.

Will strategic defaults continue to climb? Will house values continue to slide? While there may not be a clear answer to these questions, one thing is crystal clear: as house values decline, the number of people who become a strategic default statistic increases.

Justin McHood is a loan officer living in the Phoenix, Arizona area. You can find Justin on Facebook, Twitter, ActiveRain or LinkedIn and he is happy to answer any mortgage-related questions that you may have.

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