Strategic Default, according to Wikipedia, is “the decision by a borrower to stop making payments (i.e. default) on a debt despite having the financial ability to make the payments.” This practice is particularly associated with residential and commercial mortgages in which, because of a substantial drop in the value of the real estate, the property is worth less than what is owed against it and is expected to remain so for the foreseeable future.
According to a recent study by the Chicago Booth/Kellogg School Financial Trust Index, nearly one-third of all current mortgage loan defaults are considered strategic. This number has increased from 22% in March, 2009.
How can this be?
Did you get that? ONE-THIRD of mortgage loan defaults are by people who can afford to make the payments but choose not to. How can this be?
One reason, according to the study, is the increasing perception by borrowers that lenders are less likely to go after borrowers who walk away. The study indicated only 54 percent of homeowners believe the lender will pursue the borrower, compared to 56 percent only three months earlier. The likelihood of strategic default increases by 23 percent when homeowners learn that a neighbor with negative equity has received a partial loan for forgiveness.
A quick summary
Here is my understanding: home or business owners have borrowed money against their property and now, when the property has lost value, are reneging on paying the loan, even if they can afford it, because they believe the lenders will not pursue them.
Is this a strategy to consider?
I say NO for the following reasons.
You are being short sighted.
Your house is an investment. Millions have learned from this recession that real estate investments, like mutual fund investments, can go down in value. Many who saw their 401(k)s plummet in value panicked and bailed out at the very worst time: when prices were low. Don’t do the same with your house. No one knows when real estate values will rebound, but historically houses have appreciated in value. Getting out when at the bottom of the market is not strategically savvy.
Your lender will come after you.
Don’t think that walking out will somehow magically make your life better. Maybe nothing will happen immediately, but you had better be looking over your shoulder. Mortgage recoveries, according to a Bloomberg report, rose 48 percent to a record $1.01 billion in the first nine months of last year compared with the year-earlier period. Foreclosure will eventually happen, including legal action to collect the shortfall between your debt and the sale price of the house. This could include the garnishing of your bank accounts or your pay check.
You will trash your credit.
Foreclosure is right behind bankruptcy in great ways to ruin your credit rating. You don’t want that foreclosure following you around on your credit report for years to come.
You signed up for the ride.
Even if none of the previous reasons can dissuade you, it is just plain wrong to not pay a debt you signed up for and can afford to make. Keep making your payments so you can look yourself in the mirror and be proud of what you see.
I am not unsympathetic toward those whose homes have plummeted in value during the recent recession. Many have simply been dealt a bad hand. However, true character is defined by how people respond to difficult times. A strategic default is a fancy term for intentionally breaking a contract because it doesn’t suit you at the time. I wonder: what else would you also bail out on when things don’t go well?
Hopefully, you don’t want to find out. Do the right thing now so you can stand tall in your own eyes. That is your only choice.
Readers: Have you ever done a strategic default? How did it turn out? In what ways was it like or different than what I have described in this post?
What are your thoughts on the moral implications of a strategic default?