America’s star crossed love affair with home ownership is giving way to the infidelity of strategic defaults.
In the second report in as many months, a growing number of bank risk officials expect strategic defaults to exceed 2011 levels.
Credit score system giant FICO recently announced that 46 percent of surveyed bank officials expect to see more strategic defaults in the nation this year, compared to last year, largely due to the number of underwater homeowners (25 percent) – those paying for mortgages with balances larger than their home is worth.
“After five years of a brutal housing market, many people now view their homes more objectively and with less sentimentality,” said Dr. Andrew Jennings chief analytics officer at FICO and head of FICO Labs.
“Regardless of legal or ethical issues around strategic defaults, lenders must account for this risk when they evaluate mortgage applications in declining markets. Many homeowners who find themselves upside down on mortgages in the future are likely to consider strategic default as an acceptable exit strategy,” Jennings said.
Strategic defaults are often a tactic used by those with underwater mortgages, who can pay their mortgage on time but don’t to get the attention of their lender or mortgage servicers for a loan modification, refinance, principal reduction or other work out.
Other underwater homeowners are just sick of paying for an investment that could take years to payoff, if ever.
In another recent survey Housing Predictor found that 47 percent of those surveyed said they would commit strategic default – 36 percent said they would walk away from their mortgage specifically if housing prices kept falling, up from 32 percent in a previous survey.
Strategic default fallout
“It is important for homeowners to realize a strategic default is never strategic,” said Joy Bender, a real estate agent with Trinity Homes and Investments in San Diego.
In addition to critics who consider turning in the home keys the immoral behavior of deadbeats, strategic defaulting is akin to suicide for your credit life.
• After a foreclosure, your credit score can drop 150 points or more, according to FICO.
• Only bankruptcy is more damaging to your credit than a foreclosure. Even if you continue to pay your other bills, the foreclosure remains on your credit report for seven years. Bankruptcy’s black mark remains for 10 years. A short sale, loan modification, government refinance or other workout is a better deal.
• After a foreclosure, any credit and insurance available to you will cost more and you could find it tough to rent the best homes. Employers can’t get your score, but they can have a look at your credit report, in some states, under certain circumstances, but always only with your written consent. If you refuse, you may have to look elsewhere for work.
• You could face legal costs if the lender comes after you for the difference between what is owed on the mortgage and what a foreclosure sale brings.
• In 2010, Fannie Mae implemented a policy that prohibits strategic defaulters from getting a new Fannie Mae-backed mortgage for seven years from the date of foreclosure.
FICO, in a previous study may have inadvertently created ablueprint for strategic defaults, also found concerns about strategic defaults reflected in response to a question about consumer payment priorities. When asked if the current generation of homeowners considers their mortgage to be their most important credit obligation, 49 percent of bankers said “no”.
Signs of stability amid continued tight credit
FICO did find some signs pointing to growing stability in the housing market.
More respondents (26 percent) expected delinquencies on mortgages to decline in the coming months than at any previous time in the two years FICO has been conducting this survey. Furthermore, 53 percent of respondents said the housing market would improve by the end of 2012, compared to 24 percent who said the market would deteriorate.
“Lenders seem to believe the housing market is starting to stabilize,” said Jennings.
“Defaults, whether strategic or not, continue to be problematic. However, a gradually improving job market could begin changing the dynamics in housing. If job creation continues, banks will be more likely to embrace mortgage lending once again. A healthy job market is essential for improving the quality of mortgage applications and reducing default risk,” Jennings added.
Right now, however, strategic defaulters are not being replaced by new homeowners. The supply of mortgage money remains thin.
Among FICO survey respondents, 56 percent expected the supply of credit for residential mortgages to fall short of demand over the next six months. A similar 53 percent majority expected the supply of credit for mortgage refinancing to fall short of demand.