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Posts Tagged ‘strategic default’

Strategic defaults are on the rise. The number of “strategic defaults” doubled from 2007 and 2008 (588,000 in 2008) and now comprise more than a quarter of mortgage defaults. I’ve also seen both 16% and 17% quoted.

So what is a strategic default? A strategic default is when a homeowner (presumably includes investors) walks away from his mortgage payment when he or she is still fully able to pay.

Strategic defaulters get special scorn for their actions. Never mind that it would take fully 60 years, in one example, to recoup their losses, you are a deadbeat for walking away according to Henry Paulson (even though it’s a “good business decision” in other arenas).

I wanted a more precise definition of is considered a strategic default, while I’m sure there are situations where it is perfectly clear that the borrower could afford the mortgage, it’s not always a black and white scenario. What if you could scrape together the money every month but it required a second job to do so? If you decided that after a year of insane workweeks you couldn’t keep it up, would you fall into the “strategically defaulting” camp?

Per studies done by Experian and Oliver Wyman people who strategically default have a different profile than the classic borrower in trouble. Borrowers who are strategic defaulters will typically have a high credit score and suddenly default on the mortgage without warning, but on no other debts. Compare this to the typical pattern of financial distress on multiple debts, where the mortgage payment is the last thing that a borrower will give up paying on. Strategic defaulters are typically concentrated in the negative equity markets and often have large mortgage balances.

The exact criteria that Experian-Wyman used to mine 24 million credit histories to find the 588,000 strategic defaults in 2008, is the following: “We define such borrowers as those who rolled straight from current to 180+ [days past due], while staying current on all their non-real estate debt obligations, 6 months after they first went 60 [days past due] on their mortgage.” With this definition, my “second job” scenario I outlined above, would be considered in scope.

The recommendation is to not offer these borrowers loan modifications. I guess the option of offering to reduce the principal balance still appears to be a foreign concept to the lenders.

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