Some Owners 'Mimic Investors'
Many agree the ranks of people taking this route are growing, but putting a number on the trend isn't as easy. To measure the number of people who are strategically defaulting on their mortgage obligations, you have to assess borrower intent.
"Take all the numbers with a grain of salt, because it's one of those topics which is really difficult to get a firm grasp on," Sharga said. "The projections are based on limited sample sizes, and [people are] doing projections that have a lot of implications on societal behavior and political policy."
Researchers believe that being underwater on a loan is a prerequisite to strategic default, and the more underwater you are, the likelier you are to consider defaulting-even if you can afford to keep making payments.
"In our data, what we've noticed is at about 25% negative equity, the behavior of owners begins to mimic that of investors-they're more ruthless and rational, they're looking at it from a cash-flow perspective," Khater said. "The default rate rises as the negative equity gets deeper and deeper."
Here are some estimates of how big a problem strategic default is:
- Morgan Stanley's recent report examined the payment habits of 6.5 million borrowers with first-lien mortgages that originated in 2004 or later, and estimated that 12% of all mortgage defaults were strategic in February-that is, the borrower who is underwater on his or her mortgage obligations and stops paying on that home loan, yet still meets other, "meaningful" non-mortgage obligations. The authors used data from TransUnion in their analysis. The report found that the incidence of strategic default is higher among those with higher credit scores and larger loan balances.
- Analysis from Experian and Oliver Wyman estimated that strategic defaulters made up about 18% of all borrowers who went 60 days past due on their mortgage in the fourth quarter of 2008; about 588,000 borrowers strategically defaulted in 2008, up 128% from 2007. Strategic default was also found to be most prevalent in areas that experienced steep price declines, including California and Florida, and among mortgages that originated in or after 2006, because those borrowers didn't experience home price appreciation before prices headed south.
- Research from the Chicago Booth/Kellogg School Financial Trust Index found a rising percentage of homeowners are willing to strategically default: The percentage of foreclosures perceived to be strategic was 31% in March, compared with 22% in March 2009. The data are collected through a survey of about 1,000 people.
One possible reason the numbers are rising is some homeowners' belief that lenders aren't aggressively pursuing those who default, according to the Chicago Booth/Kellogg School report.
"With more and more homeowners believing that lenders are failing to pursue those who default on their mortgages, there is a risk that a growing number of homeowners will walk away from their homes even if they can afford monthly payments," said Paola Sapienza, professor of finance at the Kellogg School of Management at Northwestern University and co-author of the report, in a news release. Zingales was a co-author.
People are also learning they often have one or
two years before they get thrown out of a home after stopping payments,
said Frank Pallotta of RH Reward, or Responsible Homeowner Reward, a
program that works with lenders to provide financial incentives for
borrowers who are at a high risk of strategically defaulting.
Getting Above Water
A recovery in home prices could give people hope to stick it out and stay in their homes, even if they're underwater, Zingales said. "If prices were to drop again, people might lose hope," he said.
CoreLogic estimates that the typical underwater borrower is five to seven years away from regaining their lost equity.
Eventually, those who do stick it out will see their equity increase due to simple amortization: Over time, less of your payment is going to interest and more is going to the paying down of principal, Khater said. "If they remain current on their home, simply paying their loan will help drive them back to positive equity," he said.
But for some homeowners, that won't be enough.
"Strategic default will begin to pick up in numbers as the housing market begins to stabilize," Pallotta said. "Now you can almost quantify how long it is to see the light at the end of the tunnel."
If people figure they'll wait more than a decade before regaining the equity they've lost, they're much more likely to cut bait and leave, he said.
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