Strategic Default: Everybody’s Doing It

Real Estate Agent with Starlight Realty Certified REO & Short Sale Specialist

Mention strategic default in a roomful of people, and you’re bound to get some strong opinions. Homeowners refusing to pay their mortgages is a rather new and startling phenomenon. Default is understandable when homeowners are down on their luck. But studies show that strategic defaulters are typically upscale and educated, with high credit scores. So much for conventional wisdom.

As with many social trends, the practice has become more acceptable as people see their friends and neighbors doing it. But middle class Americans are not typically comfortable abandoning their obligations. The issue of strategic default raises a raft of moral issues which have yet to be resolved. And as this MSN article illustrates, the attitudes of normal, decent homeowners can migrate from discomfort to acceptance as they watch their equity sink—and as walking away becomes a viable option.

Here’s a distilled version of some common water-cooler arguments—pro and con:

Pro: The banks ripped off the public and now they’re getting what they deserve. Their only relationship to these defaulting homeowners—or the homes—is on paper. No one should feel a moral obligation to them.

Con: Mortgage loans are legally binding contracts. To deliberately dishonor a consensual agreement when one has the power to fulfill it is morally wrong. If we condone this type of behavior, no contract will ever be secure again. It undermines the entire basis of a free society: the sanctity of agreements willingly entered into by competent adults.

No sign of common ground yet between those two opinions.

Moral hazard is a term that describes economic incentives to do the wrong thing. There was plenty of that in the loose lending practices that preceded the housing bust: Why not lie about your income? The important thing is to get into the house. The value is only going to go up, so if you can’t afford the payments, just refinance—or sell and you’ll make a profit!

Now, there’s moral hazard from the other direction: By refusing to address homeowners’ equity loss, banks are essentially saying, Your home is only worth half what you owe on it? Too bad. Just keep paying us. You have no hope of ever breaking even again in your lifetime? That’s your problem. Pay us.

It would be hard to conceive a more powerful incentive to abandon an obligation. And homeowners know that foreclosure can take years, so they can potentially live rent-free for a long time. Put it all together, and the mortgage industry has a big problem.

As the default crisis deepens, will it get smaller—or bigger?

What do you think?

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