This article hit over the weekend in the Washington Post…
It’s enlightening…and some may even find it shocking!
Who are the folks more likely to “strategically default”?
The “Super Prime” FICO scorers! Yes, the snooty folks that look down on us with the less than 700 scores are 28% more likely to strategically default on their home mortgage.
What’s a strategic default?
- It’s the action of choosing to walk away from your obligation or in this case, the mortgage on a home.
Why would an “Elite” Scorer strategically default?
- Simple…the realization that the value of the investment has decreased and is now a true “liability”.
What are the liabilities of a strategic default?
- Shows that you made no attempt to mitigate the loss.
- 7-10 years of negative reporting.
- Inability to secure a mortgage for 5+ years
My thoughts are that these “Elite-ests” are simply making an educated decision to cut their losses.
The interesting thing I am not reading here is that these “educated” scorers are not taking the next step and seeking guidance on minimizing the hit or impact to their credit. This can be accomplished by completing a short sale.
- Short Sale: The process in which your mortgage company agrees to accept less than what is owed on the mortgage.
- Often this is reported to credit agencies as “payed as agreed” and will only take a 50 to 100 point reduction to the credit score.
A new discussion is that of the the “Strategic Short Sale” and it’s acceptance by many lenders.
What is a Strategic Short Sale?
- It’s the process of hiring a licensed real estate agent to sell your home for less that what is owed and working directly with your lender to accept the short sale…
- Doesn’t sound any different than a short sale…well that’s true…however, you are making an educated decision to sell the property and minimizing the loss to your mortgage company and reducing your potential liability.
- Did you say Liability??? Yes, you may be liable to resolve…much like the television commercials that claim “they negotiate on your behalf to reduce your IRS debt for pennies on the dollar”. You’ll find that most lenders will “negotiate” with you on your debt.
- In California, if you did not refinance your home, you may not be liable for anything…but we’ll need to talk to you about that…this is better known as “non recourse”.
- Think about this scenario:
- Purchased $1Mllion home in 2005.
- Home value is now $650,000
- That’s $350,000 in potential liability or unpaid debt.
- The bank in some cases may ask you to contribute 5 -10% of the amount or in this case up to $35,000 to eliminate the debt…Now…Thats a sweet deal to minimize your credit score liability.
This is just 1 scenario…however, you need to understand your options and Short Sell that property instead of burdening your self and your credit for years to come.
The Washington Post article is below for your entertainment.
New research based on data from 25 million active consumer credit files suggests the answer just might be no. Although people with the highest-ranking credit scores are less likely to default on their mortgage compared with people with lower scores, when they do default, they are much more likely to do it strategically: They simply stop paying with little or no warning. In a study released June 28, researchers from credit-bureau giant Experian and the Oliver Wyman consulting firm found that borrowers with “super prime” credit scores accounted for 30 percent of all mortgages outstanding in mid-2009 but produced just 5 percent of all serious mortgage delinquencies. However, 28 percent of those elite scorers’ defaults were calculated and strategic, versus 18 percent for the overall population of borrowers in the sample. This pattern, in turn, is forcing lenders and the credit industry to seek new ways to evaluate risk beyond traditional credit scores. Charles Chung, Experian’s general manager of decision sciences, said in an interview that “lenders not only are looking at creditworthiness,” as measured by traditional credit scoring models, but also at applicants’ likely “ability to pay” under scenarios in which real estate values drop. Lenders might need to adjust underwriting and risk-rating rules — requiring higher minimum-down payments or higher interest rates — to deal with loan applicants who fit the profile for walkaways in a depreciating real estate market. The latest study, which follows up on research involving credit files where consumers’ personal identifiers had been removed, tracked strategic defaulters in 2009. By examining payment patterns in individual credit files, Experian and Oliver Wyman estimate that about 19 percent of all mortgage defaults last year involved intentional, strategic walkaways. Although there was some evidence that total defaults might have peaked at the end of 2008, the walkaway issue remains a costly and controversial one for the mortgage industry. Fannie Mae announced late last month that strategic defaults have become such a problem that it is toughening its policy and will pursue walkaways for unpaid balances and penalties wherever permitted by state law.
The Experian-Oliver Wyman study confirmed that geography plays a significant role in the strategic default phenomenon. Homeowners in volatile boom and bust states. includings California and Florida, have been especially prone to walk away from deeply negative equity situations. A separate study by three researchers at the Federal Reserve found that not only is geography crucial but also that state laws’ treatment of unpaid mortgage balances after a walkaway might play a major role. The Fed study examined 133,281 loan histories in Arizona, California, Florida and Nevada where borrowers were underwater on their loans. According to the researchers, in California and Arizona, where state law restricts lenders’ abilities to collect post-foreclosure deficiencies on mortgages, borrowers were more prone to walk away from their homes at lower levels of negative equity than borrowers in Florida and Nevada, where lenders face fewer restrictions. “This result suggests,” the Fed study said, “that borrowers may factor into the costs of default the potential legal liabilities resulting from a foreclosure.” The Fed researchers concluded that the depth of borrowers’ negative equity is an important tripwire to their decision to send back the keys. Borrowers whose negative equity is relatively modest appear to be much less willing to strategically default, probably because they hold out hope that market conditions will improve enough to restore them to positive equity. But as negative equity approaches 50 percent — and borrowers see no prospects for higher real estate values — roughly half of all defaults are strategic. The Fed researchers cited a hypothetical case in Palmdale, Calif., to illustrate the economic logic of strategic defaulters: Purchasers there in 2006 paid $375,000 for a median-priced single-family home. By last year, it was worth less than $200,000. Meanwhile, a three- to four-bedroom house rented for $1,300 a month at the end of last year, far less than what the borrowers were paying. Why stay in a hopeless situation? Both studies document that many borrowers asked themselves that — and decided to just stop paying. 