Strategic Defaults: It Depends How Far Under Water You Are

Posted on November 23 By Justin McHood

The term "Strategic Default" has been actively reported on for the last few months as more homeowners who can afford their mortgage payment just "walk away" for various reasons.

And the #1 reason they walk away is because they owe more than the home is worth.

And according to the latest research, the larger the negative equity, the higher the chance of someone defaulting on their mortgage no matter what their credit score is.

According to a story in the LATimes regarding the Strategic Default problem:

But research by three academics suggests that the willingness of people to default depends largely on just how far underwater they are. Or, as the study's authors put it, "People default because of the size of their negative equity, not just because they cannot afford to pay."

When the difference between what they owe and what their homes are worth is less than 10%, the researchers found that not one of the 1,000 U.S. households sampled said they would walk away.

And when the shortfall is between 10% and 20% of their home's value, Luigi Zingales of the University of Chicago, Paola Sapienza of Northwestern University and Luigi Guiso of the European University Institute found that just 5% of the owners they sampled would quit. Even when the difference reaches 50%, only 17% said they would throw in the towel.

And it appears that at least one factor when making the decision to default or not when you can afford your mortgage is how many of your neighbors are doing it.

Then there is something the study's authors call a "multiplication effect," meaning that the social pressure not to default is weakened when the borrower lives in an area with a large number of foreclosures. The predisposition to run away increases with the number of foreclosures in the same ZIP Code, the study found.

Lastly, many homeowners are finding that the banks are "just asking for more foreclosures" because they are not working with homeowners as much as they could.

Deede Wockenfuss of CybrSold Concepts in Chandler, Ariz., has had several clients who tried to no avail to work with lenders to get their loans modified. "The bank is asking the borrower to default," she said.

When push comes to shoving your loved ones out the door, Bob Hunt of Keller Williams O.C. Coastal Realty in San Clemente says the moral duty to protect your family outweighs the moral duty to repay the loan.

Regardless of whether someone can afford to pay their monthly mortgage payment, one thing is clear: the more that their house is "under water" the greater the chance is of them defaulting.

No matter where they live.

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