Home > Mortgages > Strategic Default and the Morality of Walking Away

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HouseKeys_Linus_BohmanA few weeks ago I talked to a friend about his mortgage. Like many homeowners, he and his wife have seen the value of their house plummet since they bought it three years ago. Despite putting down 20 percent, their house is now underwater, meaning they owe more than it’s worth. It’s a distinction they share with 27 percent of American homeowners.

My friend – let’s call him Brad – doesn’t have many good choices. He and his wife – let’s call her Angelina – could hold on to the place and hope the market rebounds. But they need more space, so that’s not ideal. They could sell it at a loss, but they’d lose their entire down payment and still be out of pocket. That obviously doesn’t appeal. They could try to rent it out and rent something bigger, but the math doesn’t quite work for that option, either.

I told Brad about a third option… called strategic default.

The tactic

A strategic default occurs when someone simply decides to stop paying their mortgage and property taxes, and chooses to let their house fall into foreclosure. The bank that holds the note on the house takes possession of the property and eventually sells it. It also gets to keep the down payment and everything that’s been paid on the mortgage up to that time. Meanwhile, the homeowner gets to live in the house without paying a dime until the foreclosure goes through and the bank takes possession.

[Related: Why the Home Loan Mod Program is Failing]

The average homeowner facing foreclosure hasn’t made a payment in 507 days, which means that by the time they are forced to vacate, they can live rent-free for as long as two years, and maybe longer, according to a recent report. Ideally, this affords them a chance to recoup a sizeable chunk of the money they put down on the house. And though the stain of foreclosure on their credit report will likely prevent them from buying a house for the better part of the next decade, they will have saved up enough to rent a pretty nice place in the interim. They also should be able to save lots of money toward the down payment on a future house.

Sounds like a no-brainer, right? Well, when Brad told Angelina about strategic default, she said it was simply not an option…and she barred Brad from talking to me about real estate ever again.

Angelina’s aversion to strategic default is hardly unique. A recent Credit.com-GFK survey indicates that most Americans oppose the idea. We asked participants if they’d do a strategic default if their homes were underwater. We explained that it could mean living for up to two years rent-free, in return for a seven-year stain on their credit reports.

This national RDD Probability Sample telephone poll was conducted for Credit.com by GfK Custom Research North America from January 14-16, 2011. A total of 1,004 interviews were completed, with roughly 531 female adults and 473 male adults. The margin of error is +/- 3 percentage points for the full sample.

The results couldn’t have been clearer. More than 83 percent of respondents say they were either ‘not very’ or ‘not at all’ likely to do a strategic default.

The dilemma »

Photo: Linus Bohman, via Flickr.com; Graph: Credit.com

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  • Sara

    “When the banks refuse to even consider reducing the principal on a loan that is hundreds of thousands of dollars underwater, they are telling the homeowner to exercise the termination clause that strategic default provides.”

    Thanks for putting that so well, Mark.

    Now happily renting. Really have no desire to buy again.

    Still hoping those responsible for the Great Swindle of 2008 are brought to justice. I won’t be holding my breath though.

  • http://www.home-liberty.com Mark Moore

    Mike, your article doesn’t discuss much about the actual morality of strategic default (SD), though it does touch on Angelina’s moral repugnance.

    The best moral analysis I have seen was written by Brent White, a professor at UofA,[1]

    I think the parties to a bad contract have a moral obligation to try and negotiate a better (mutually agreeable) arrangement in good faith.

    If they can’t find a fair and mutually agreeable solution, then basically, the gloves are off and anything the contract and the law allow should be “morally acceptable.”

    When the banks refuse to even consider reducing the principal on a loan that is hundreds of thousands of dollars underwater, they are telling the homeowner to exercise the termination clause that strategic default provides.


    [1] http://www.sacbee.com/static/weblogs/real_estate/SSRN-id1494467.pdf

  • Jon

    Although I’m not opposed to the idea of strategic default, I’m a little baffled by some of the rationale by some of these comments.

    Maybe the banks shouldn’t have made these loans (and the politicians on both sides were complicit). But you realize that the bank didn’t decide the sales price of the homes when you purchased them, right? And that it was the seller, not the bank, that received the inflated price? The bank is legitimately out every dollar they loaned you. It’s ridiculous to expect them to change the amount owed just because the value changed.

    That would be like getting a loan for a new car, driving it 10K miles, checking the Kelly Blue book value of the car, and calling up the bank and arguing that the car isn’t worth $30K anymore, so you shouldn’t owe $30K. Seriously???

    But, the bank did sign the contract too, so I really don’t have an argument against strategic default. They price that risk into the loans. Like I said, they shouldn’t have made many of these loans, and if they get bit for that, so be it.

  • ed

    A mortgage is a contract like any other. It has terms and conditions and can be amended by mutual agreement. One of the conditions is if I don’t pay, the bank takes my house and my debt is satisfied (I live in a non-recourse state). I have tried repeatedly to get the bank to lower the principal to the current market value but they have absolutely refused to even consider this (My mortgage is approx 2x what the house is worth). It makes no financial sense to keep paying as my home will never again be worth what I owe so I’ve stopped paying. If the bank won’t make a deal, they can have the house back.

  • John

    Although I’m a home owner and I live in the area of the country where home values have deprecieated much less, I empathize with Sara and I share her sentiments in regard to the banks.

    The banks and mortgage companies were making bad loans and passing them on like hot potatos. And both political parties were complicit in making this happen. They should all be hung for treason for creating this economic disaster.

    There were unscrupulous home owneres and investors, too. And consumers did use their homes like piggy banks. But, it was all sanction by the money lenders and their litttle congresspersons they keep in their pocket.

    I was approved for a home loan at twice the value of the home I purchased. However, I was concerned about being overly extended. That was one of my better financial decissions.

    But, if a home owner like Sara is hopelessly upside down in her mortgage, I can’t blame her. It is a financial decision and large and small banks and businesses do this all the time. However, if she was my neighbor, I wouldn’t appreciate it.

    I’d rather take the pitchfork after the mortgage companies, banks and our congresspersons.

  • Strategic Defaulter

    December was the first payment we missed. We have not yet received a notice of default, so we calculate that we have a minimum of 3-4 months left (and it could be much, much longer, depending on how things turn out and how many foreclosures the bank has to process). We are continuing to pay for HOA dues as the homeowners’ association can and will go after you for unpaid dues, so we are not completely living “rent free.” As for the money that would have gone toward paying mortgage and property taxes, we set up a separate savings account. That way, we can track how much we’ve “saved” – so far, we are up to almost $10K!

    For those considering walking, I would definitely consult with a real estate attorney as each state (and each situation) is different.

    • Michael Schreiber

      Thanks for sharing that. Agree. Consulting with an attorney is very sound advice.

    • Unbelievable

      I can understand someone being down on their luck, but this sounds cheating to me. How clever for one couple to call their ill-gotten funds “savings”. When you intentionally take something without paying for it, it’s usually called stealing. I’m not surprised one lawyer would advise a client to take the money and run, lawyers advise guilty folks all the time. I just wouldn’t consider a lawyer’s advice to a defendant justification for any practice. I guess we should blame the banks for the “default”, because they chose to deal with this element of society. Scheming and conniving out of a legal agreement is morally bankrupt. Paying two or tree times what a house is worth because you can borrow the money is just plain stupid.

      • Jak

        WWTDD? (What would the Donald do?) Well, he’d view it all as “just business” and treat the underwater property as a “market failure”. One of the few times I might agree with The Donald…..

  • http://hubpages.com/hub/Strategic-Default-Is-Growing-In-Popularity-Finally Gary Anderson

    Strategic default is growing in popularity and since the ponzi housing scheme was a Wall Street churn, with borrowers set up to do the churning, there is nothing immoral about walking away.

  • Strategic Defaulter

    My husband and I missed our first mortgage payment in December (the first payment I have ever even been late on in my entire life!). We both have stable jobs, excellent credit, and can afford the payments, but our house has devalued significantly (our purchase price in 2007 was $531K, and zillow.com has it currently valued at $246K – even though it appraised for $305K a few months ago). We do not want to become prisoners in our townhome that will be too small once we have children, and the only way to get out is to just give it back to the bank… Though the damage to our credit will be great, we have calculated that the time it will take to repair our credit will be less than the time it will take for our house to appreciate even back to our original purchase price (and we can rent for 30-40% cheaper in the meantime). I am even willing to bet that in 7 years, we will be able to buy back the home we are foreclosing on for less than what we currently owe!

    Before coming to this decision, we tried to refinance and work with the bank, but the bank told us we didn’t qualify because our loan-to-value ratio was outside their limits. If it doesn’t make sense for them to refinance us because the value is so low, why would it make sense for me to keep paying the inflated mortgage amount?!

    Deciding to default was not an easy decision, but we consulted with an attorney who told us to run and not look back. We didn’t want to come to this decision, but it is the unwillingness of the bank to negotiate that pushed us here. Luckily, we have a non-recourse loan, so we do not have to worry about being sued for the deficiency.

    • Michael Schreiber

      Curious… How long did you live, or have you been living in the home, without paying?

  • Michael Schreiber

    Sounds like you mean business, Sara. Any concern that in the states where recourse is allowed banks would start suing borrowers for the balance?

    • Sara

      Sure, I suppose the big banks could very well go after people to recoup their losses in those recourse states. I don’t know how something like that would play out politically though. Banks that received TARP money were supposed to make a good faith effort to work with troubled loans. They haven’t done that.

      If large numbers of people started choosing strategic default, I don’t think big banks would be doing anything to improve their reputations by going after people on a grand scale. And I don’t know that politicians would be scoring votes for their reelections if they supported banks in their endeavors to reclaim such losses.
      And people could always fight back by giving up on big banks altogether. There are credit unions, and we are members of ours.

      Oh, and thankfully, I’m in a non-recourse state.

  • Call me Sara, Sara Strategic Default

    No the borrower is not morally required to hand over even more money to the lender who wrecked the housing market in the first place. If they hadn’t sold to people who really couldn’t afford homes in the first place, then we wouldn’t be in this mess. But the banks did it because it was profitable. They were making money, money, money!

    And they have already been paid, again–with TARP (my taxes, all of our taxes).

    Main Street still hasn’t gotten a bailout, and probably never will. The supposed government subsidized “mortgage renegotiation” programs aren’t happening. Our bank got TARP funds, and they won’t renegotiate.

    The borrower had an “appraisal” done on the house before we purchased it. It was for $325,000. Now, It’s down to $90,000.

    It was our dream home. But now I see it for what it really was… a statistic of the GREAT SWINDLE. Sorry we’re on the losing end, of course. Strategic default is our solution. More people should go this route. Maybe then the banks WOULD do something, like renegotiate the loans of those who can hold on until that happens?

    The banks and bankers know where they can go.

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