New Vocabulary for a New Market –“Strategic Default”

It used to be unthinkable to stop paying the mortgage.

More Americans are finding themselves “underwater” on their mortgages. They owe more to the bank than their properties are worth. A house that was purchased for $240,000 several years ago, and there is still $218,000 outstanding on the loan, now finds the property is only worth $130,00 or less. Even if the homeowner can still afford to pay, should they? Especially when they can rent a comparable space for less than their mortgage payment.

More and more people, where house values have plumpeted are considering a “strategic default” – walking away from their mortages – not out of necessity, but because they think it is in their financial best interest.

A standard mortgage-loan document reads, "I promise to pay" the amount borrowed plus interest, and some people say that promise should remain good even if it is no longer convenient. What makes it immoral for a homeowner to walk away from debt, but we have allowed banks to walk away from debt with impunity? Should borrowers take a cue from lenders that ruthlessly sought to maximize profits or minimize losses irrespective of concerns of morality or social responsibility.

Strategic Default is not without its risks. Walking away isn't risk-free. A foreclosure stays on a consumer's credit record for seven years and can send a credit score plunging. A lower credit score means auto and other loans are likely to come with much higher interest rates, and credit card issuers may charge more interest or refuse to issue a card.

As the idea of a strategic default makes more sense to homeowners with negative equity, will we see more decline in values. In neighborhoods with high concentrations of foreclosures, is it going to be really difficult to prevent a “cascade effect" as one strategic default emboldens others to take that drastic step?

First American CoreLogic, a real-estate information company, estimates that 5.3 million U.S. households have mortgage balances at least 20% higher than their homes' value, and 2.2 million of those households are at least 50% under water. The problem is concentrated in Arizona, California, Florida, Michigan and Nevada.

What would you do?

If You Walk Away, Who Can Sue You for a Deficiency Judgment... And Will They?