It feels like I posted just yesterday on the topic of walking away from a mortgage, but I checked and it was in fact 2 weeks ago -- how time flies! Nevertheless, I’m not a fan of belaboring points, but this one just keeps rearing its head -- in the blogosphere and in the mainstream news. And since most Phoenicians are, in one way or another, affected by foreclosures, I thought it appropriate to address the issue again.
This time, I have a name for what I’ve been referring to as “walking away” -- it’s apparently called a “strategic default” -- at least according to the folks in the University of Chicago economics department. Several professors there released a paper earlier this month revealing that a whopping 26% of all mortgage defaults are strategic -- meaning the homeowners are defaulting even though they can afford to pay their mortgage.
The professors make some interesting points. Among them:
No household would default if the equity shortfall is less than 10% of the value of the house. (Calculate the equity shortfall like this: house value - mortgage = equity shortfall. So if a house is worth $165,000 and the mortgage is $181,500 then the equity is -$16,500, or 10% of the value of the house.)
17% of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50% of the value of their house. (So if a house is worth $165,000 and the mortgage is $247,500 then the equity is -$82,500, or 50% of the value of the house.)
People who know someone who defaulted are 82% more likely to declare their intention to do the same. In other words, in communities where foreclosure rates are very high, strategic defaults are more likely.
In contrast to defaults that occur because the homeowner’s mortgage rate adjusts to an unaffordable level or because of an unexpected event like illness or job loss, strategic defaults are almost entirely due to negative equity -- when a homeowner owes more on the mortgage than the home is worth.
Zillow.com estimates that 22% of all homeowners in the U.S. have negative equity. In the Phoenix Metro area, 80% of homeowners with nonprime mortgages do.
But, as the professors point out, it’s not so much the fact of being underwater as it is the magnitude of the negative equity. According to a study by the Federal Reserve Bank of New York, among nonprime borrowers (subprime and Alt-A) in Phoenix the average amount of negative equity is $73,314 (in other words, the average home is worth $73,314 less than the mortgage on that home).
In many areas of the Valley the equity shortfall approaches 100%. For example, a friend of mine in Queen Creek owes $290,000 on her house that is now worth $150,000 -- her equity shortfall as a % of her house value is 93%.
Okay, so those are the numbers. What can you do about it? Stay tuned for next week’s post The ABCs of “Strategic” Mortgage Defaults.
What do you think? Do you know someone who has “strategically” defaulted? Click on the “Comments” link below and join the discussion!
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