Expiring Mortgage Debt Forgiveness Act To Increase Strategic Defaults?

Last December I blogged about strategic default.  That is, consumers who walk away from their mortgage even though they have the ability to continue making their payments. It results in foreclosure, of course.

If the Mortgage Debt Act is allowed to expire by a deadlocked Congress, will this encourage more struggling homeowners to walk away instead of trying to sell their homes by short sale?  Currently, homeowners don’t have to pay tax on the forgiven debt.  If the Act expires, the forgiven debt will be treated as income (a ‘gift’) and will be taxable.

In September (2012) Housing Wire reported that 1 million Home Affordable Modification Program (HAMP) loan modifications were cancelled by lenders after their 3 month trial. HAMP terms are likely the most appealing to homeowners having financial difficulties – if they qualify. The government predicted this program would help 3 to 4 million homeowners, but as of September 2012, only about 825 thousand made it past the three month trial period. Less than $3 billion of the over $29 billion set aside for this program was actually spent.

Home Affordable Refinance Program (HARP) and lender-based refinances are also options, but they also have requirements that may be tough to meet or the savings may be minimal. That’s why short sales remained attractive to many underwater homeowners.

Like all things financial right now, these are complicated and interwoven subjects, but it seems possible that the expiration of the Mortgage Debt Forgiveness Act will have the effect of causing more strategic defaults and therefore foreclosures.  Write your legislators and tell them to extend the Act today.

Confused about short sales, or need to explore the options for the sale of your home? Give me a call for a no-pressure appointment.

Study Shows Strategic Default Influenced By Social Circle

Strategic default is defined as walking away from a mortgage that you have the ability to pay. Why do homeowners do this? Or not do this? It can be pretty much broken into two schools of thought.


First, the ethical argument. You agreed to buy your house at a then fair market price with a mortgage at the then market rate. You signed a contract obligating you to keep making payments even if similar houses are now selling for half the value of what you paid. Even if a new mortgage can be obtained at a lower interest rate by another buyer. Even if you can’t refinance.

The other argument is that this is a business deal, plain and simple. If I don’t make the payments, you take the house. I’m not going to make the payments, so feel free to take the house.

The report examines the use of social media and social influence on our decision making. If enough people that you know (or are connected to) are saying its fine to strategically default, you begin to get more receptive to the idea. After all, it worked out great for them, why not me? (A lot like the continual anecdotes I hear about the ‘buddy’ that picked up a $600,000 house for $100,000 as a foreclosure - I can do it, too.)

An industry source, CoreLogic, says that 11 million homes (22 percent of the housing market) are underwater and that another 2.4 million have less than 5% equity, so there’s a lot of potential for more strategic defaults out there.

Banks are also part of the problem. People looking for refinance options often get the runaround or can’t qualify with the current stringent requirements. I know mortgage reps that can’t refi their own homes, what chance does a regular consumer have? It may be easier for some people to opt into strategic default as a result of feeling helpless, or because they think the big corporations don’t care about them.

A single strategic default (which ends up as a foreclosure home) won’t kill the value in a neighborhood. But think about the areas where there are a lot of strategic defaults in addition to the short sales and foreclosures due to hardship – loss of a spouse, losing a job, illness. Distressed sales do, in fact, bring down property values and are not good for neighborhoods. Strategic default is only a part of the overall problem.

Strategic Defaulters - FICO Has Your Number

OK, so they don't have your actual (FICO Score) number, but they do have a profile of who is most likely to use strategic default as an exit strategy. You manage your credit better than the average consumer, have lower revolving balances and generally, you don't exceed your credit card balances.

Strategic default is generally accepted to mean default by a consumer that still has the ability to make payments. Often these folks are value-keyed, figuring that if they walk away from a home that isn't worth what they owe, perhaps they can also pick up another home at a cheaper price before the default impacts their credit.

If you are not facing an economic hardship, you will not be eligible for a short sale, which is the route many distressed homeowners first explore.  Since those considering a strategic default are not in a 'distressed' condition (other than overthinking the value of their homes against current market prices), strategic default often seems like a good idea to them. 

This 'profiling' could help servicers to reach those considering strategic default before they make that final decision. The analytics developed by FICO Labs indicate that the riskiest 20 percent of borrowers actually comprised 67 percent of consumers who later executed a strategic default. To me, that's an amazing number.

In this report from DSNews.com, Dr. Andrew Jennings, chief analytics officer at the Minneapolis-based FICO and head of FICO Labs said, "Strategic defaults are bad for lenders and investors, they're bad for the homeowners who elect to default and they're bad for neighborhoods and cities. Preventing them is in the interests of everyone involved."

You can read the entire article at DSNews.com by using this link.