But is the bad economy driving homeowners to commit fraud against mortgage lenders? Is it worth getting caught and paying a hefty penalty or going to jail? A scary new trend in mortgage fraud is known as “strategic default.”
According to credit-reporting agency Experian, at the second quarter of 2010, among all the homes that were 60 or more days past due, 17 percent were strategic defaults. While still very high, this number is down from the strategic defaulting peak in the fourth quarter of 2008, when strategic defaults were determined to represent 20 percent of the loans 60 or more days past due.
But what is a strategic default, and are they really so bad? Should the rest of us “mind our own business” while our neighbors choose this tactic as a way out of bad loans?
What is a strategic default?
It is a common practice for most banks to turn down a homeowner for loan modification until the homeowner has been delinquent for a month or more. As the banks see it, if the homeowner does not have a problem making the mortgage payment, then the homeowner must not have a financial hardship.
In a strategic default, the homeowner deliberately stops payments on their loan, claiming financial hardship to force the mortgage lender to review them for a loan modification. The homeowner places all of their blind hope on their lender reducing the principal loan amount, or lowering the monthly payment as a solution to his current high monthly mortgage payment. Some people, while still able to pay their mortgages, even choose to allow their homes to foreclose as an easy way out of a bad investment. These “strategic default” strategies are more common among homeowners who purchased their home during the recent real estate peak than those who purchased their homes earlier.
One out of four homeowners that are not making their loan payments do not suffer from financial hardships. These homeowners are choosing to short sell or even foreclose their homes because the balance owed on the loan is greater than the home’s fair market value. Is this the right thing to do? And how will a homeowner’s strategic default affect the rest of us?
Let’s explore the pros and cons of the strategic default for homeowners and the economy.
Advantages for the homeowner: One obvious advantage here is that the homeowner who defaults on his loan is cutting his losses. Additionally, by defaulting, his mortgage lender might offer loan re-negotiations that would be advantageous to the homeowner. This could save him a lot of money in the long run.
Disadvantages for the homeowner: Usually, when a homeowner defaults, purposely or not, his credit card interest rates go up immediately. His lower FICO score presents him as a bad risk to creditors. For example, let’s say his monthly payment on his six credit cards is $350. If all of those creditors demand a higher interest rate, his monthly payment can be increased by as much as three times, from $350 to $1,050.
Buying another home becomes more difficult as lenders will always check credit reports for a stable credit history. Landlords look into credit history as well, and might refuse to rent on favorable terms. Cell phone companies and utility providers do the same investigation before extending credit to clients. This can lead to a need for a security deposit, co-signers or even a denial from potential creditors or landlords.
Disadvantages for the economy: The negative effect on the local economy is obvious. Lower sale prices continue to reduce local home values in the real estate market. On a larger scale, the negative impact on the lender is far-reaching and makes the mortgage industry inefficient. As a result, the abundance of short sales and foreclosures is road-blocking the economic recovery and delays a comeback. Ultimately, everyone suffers.
Annie Christian is a real estate broker and owner of The Annie Christian Real Estate Group. She helps with everything from buying and selling to foreclosure and short sale. To submit a question, call 351-5117. Her website is www.anniechristian.com.