[This study addresses the groups that are beginning to strategically default. The banks try to push moral buttons regarding personal responsibility, especially in the courts. Does this strike anyone else as supreme hypocrisy? Even if we just conveniently forget about the origin of this crisis, the banks and big business are the first to unload a toxic asset or breach a contract for economic benefit (their own). And let’s not forget who signed off on all of these crap mortgages, oh, and made billions in the securitization thereof. Pot, meet kettle.]
The rich bail faster on mortgages
Wealthy but ‘underwater’ homeowners are giving up on paying their mortgages as a financial tactic, a study finds. Those with smaller loans are less likely to do so.
[Related content: homes, home financing, mortgage, foreclosure, credit score]
By Marilyn Lewis
Why not just walk away?
Increasingly, homeowners with good credit and no late payments are making what appears to be a strategic decision to walk away when their home’s value falls below what’s owed.
“The American consumer has had a long-held taboo against walking away from the home, and this crisis seems to be eroding that,” concludes a report on research by Experian, the credit agency, and Oliver Wyman, a management consultant company.
The better their credit rating, the more likely homeowners were to default. The trend is most pronounced where prices have fallen furthest: Florida and the West, especially California.
The finding — that 588,000 borrowers appear to have strategically defaulted in 2008, a 128% increase from the year before — surprised the researchers. Piyush Tantia, who conducted the research for Oliver Wyman, and Charles Chung of Experian spotted the trend while analyzing 24 million credit files to see what they could learn about mortgage delinquency.
Foreclosure as a financial strategy
Strategic defaulters stand out among the 14 million to 15 million “underwater” mortgages, the researchers said, because they:
Pay all their bills consistently and on time until abruptly stopping mortgage payments with no attempt to get current again.
Keep current on other debts after defaulting on the mortgage.
Keep up payments on home equity lines of credit, sometimes drawing out cash, before defaulting on both the first mortgage and credit line.
This “sophisticated” combination of moves and timing suggests borrowers are employing foreclosure as a calculated financial strategy, said Tantia and Chung.
They conclude that 18% of the borrowers with mortgages 60 days past due in the fourth quarter of 2008 were acting strategically, up from 3% — “barely noticeable,” the report says — in late 2004. Most defaults, however, are driven by financial distress. Defaults due to troubled finances grew from 31% to 51% of loans in the same time frame.
It appears that the more money people feel they’re losing, the more likely they are to bolt. Owners with smaller loans were less likely to strategically default, even when facing the same percentage of loss.
For example, “once you hit the $200,000-and-up loan size in California, you start to see about 33% strategic defaults,” said Tantia. A similar pattern, with 18% to 20% strategic defaults and lower loan amounts, plays out in the rest of the country: “This tells us that the threshold probably is a dollar value and not a percentage.”
From 2005 to 2008, strategic defaults rose by 68 times in California, by 46 times in Florida and by three to 18 times in other regions. Strategic default was seven times more common among mortgages originated in 2006 than those begun in 2004.
“Starting about a year ago, the good-credit people, the Little League coaches, the schoolteachers and the retail managers, the higher levels, started walking away,” says Kurtis Squyres, whose company, FarBelowMarket.com, buys homes in the Coachella Valley east of Los Angeles that banks have foreclosed on and sells the properties to investors. “I even had a DA who had talked about it. He was very seriously considering buying another house because his credit was still intact, and then walking. His conscience got the better of him, but that shows how tempting it is.”
Makes sense to some
Strategic defaults may sound cynical, but such calculations are becoming familiar to real-estate professionals. The word is that “your credit will heal before you recover what you borrowed against it,” says Squyres. The alternative, a short sale, is difficult, lengthy and uncertain of success, he says.
Even if true, strategic defaulters face a long sentence in credit hell: It takes seven years plus 180 days from the date of the first missed mortgage payment for a foreclosure to exit your credit record, says Liz Pulliam Weston, an MSN Money personal finance columnist.
“Your credit scores start getting trashed the minute you miss a payment. The more payments you miss, the worse the damage,” says Weston, the author of “Your Credit Score, Your Money & What’s at Stake.” “The effect on your scores diminishes over time if you handle credit responsibly from then on.”
Almost certainly your score will fall into subprime territory, a FICO score of 620 or less. “I know one real-estate investor with multiple foreclosures whose score fell to 305 — just above the absolute bottom,” Weston says.
However, real-estate agent Heidi Wyble, a short-sale expert in La Quinta, Calif., believes the statistics on strategic defaulters hide factors “behind the scenes,” like divorce, impending job loss or an unsuccessful struggle to get bank approval for a short sale. And if borrowers are becoming more ruthless, she says, banks weren’t exactly philanthropists to begin with.
Despite counseling 10 to 20 clients a week, she says she hasn’t seen many who go straight into default without a thought about their credit.
The big picture
In June, three university researchers published a separate look at strategic defaults (“Moral and Social Restraints to Strategic Default on Mortgages”). They predicted that, if a home’s value slips 15% or more below the mortgage amount, about 26% of homeowners who could afford their payments would default anyway.
“We’re in a completely different economic environment today, where for the first time since the Great Depression millions of Americans have mortgage loans that exceed the value of their home,” that paper says. It concludes that the stigma of default is less severe among people younger than 35 and older than 65, among those with higher incomes or more education and among African-Americans.
Banks and government produce reams of data on foreclosures, including missed payments, loan types and amounts and loan-to-value ratios. But lenders can’t access data on borrowers’ income and assets, which would tell more about the motivations of defaulters.
Why not just walk away?
Tantia and Chung, who oversees Experian’s “decision sciences” research, used the bigger credit picture to try to get around that limitation, hoping their work would help government and banks identify the troubled borrowers most likely to make good use of government help.
“The question that drove us to do the study in the first place is: ‘How do we avoid these foreclosures?'” said Tantia. “And all the loan modification programs that the government has launched: ‘Are they enough?'”
The researchers found distinctly different behavior among the three largest groups of people in default:
“Strategic” defaulters have perfect payment histories before suddenly going 60 days late on their mortgages. After default they remain current on other debts. Another surprise: Two-thirds of strategic defaulters bail on primary homes, not investments. However, strategic defaults are growing among owners of all homes. “It’s useless to spend energy modifying these loans because it’s not the payment that matters in their case,” says Chung. They are likely to take advantage of loan-modification programs for free rent and then default again.
“Distressed” defaulters: Most — 53% — of defaulting property owners fit the conventional picture: They skip payments on the mortgage and other debts, yet keep trying to recover by paying occasionally until they’re overwhelmed. These defaulters need loan modifications and help managing finances and even those may not be enough to prevent eventual failure.
Cash-flow “managers” are the heroes of the report; in situations identical to those of the strategic defaulters, they show the intention to make good on mortgages by continuing to try to pay even after skipping some payments. A third of this group pulls the loan out of trouble within six months. “This group’s performance is about twice as strong as average,” the report says. With resources and motivation, it found, people in this group could be the best candidates for loan-modification offers.