The national credit bureau Experian recently made a discovery while conducting research on 24 million credit files: homeowners with high credit scores are 50% more likely to strategically default than those borrowers with lower credit scores.
A strategic default involves a calculated decision to walk away from a mortgage, and thus, eventually, the house. These defaults seem sudden to lenders — a surprise since strategic defaulters typically have no history of late payments, nonpayments or other personal debt issues.
This surprise for lenders is due to the strategic defaulter’s level of financial experience. These homeowners understand the repercussions of defaulting on their home, and do not take the decision lightly. They see the need to make a practical business and financial decision to pull themselves out of an inhospitable market situation and a dead-end loan.
Naturally, strategic defaults are concentrated in markets plagued by negative equity. In California, for example, the number of strategic defaults in 2008 was 68 times higher than the number in 2005. Compare this to the rest of the nation, where the number of strategic defaults was only nine times higher in 2008 than in 2005. Californians appear to have higher credit scores and are better informed than others.
Two-thirds of strategic defaults occur for homeowners who only own a primary residence. Additionally, these mortgages have a high loan-to-value balance, one which exceeds the encumbered property’s value. Thus, the negative equity and a dead end loan.
Experian prudently declined to comment on the ethical repercussions of walking away from a mortgage, but it does recommend that lenders set up a system that identifies and excludes strategic defaulters from qualifying for loan modifications. Their reasoning: these individuals may strategically default again in the future as prices drop further in this Great Recession.
first tuesday take: Higher credit scores translate to financial savvy. These bright, well-informed homeowners are going to assess their options and make sound financial decisions for themselves, not their lenders. They are not going to languish in a home under water because of some misguided, pseudo-moral social obligation to lenders, or the financial system which paved the way to get them where they are.
Conversely, those in the lending industry want to moralize the decision to stay or leave a home under water. They shake their finger at those who walk away, claiming borrowers have some sort of social obligation beyond a legal obligation (which in California abhors deficiency judgments) committing them to payment.
But lenders had a much softer opinion on morality while they peddled subprime mortgages and adjustable rate mortgages (ARMs) of all varieties to naive, financially-stretched families with lower credit scores and less independent resolve than the financially savvy to default and rid themselves of bad debt.
Re: “Unlikely suspects walk away from mortgages,” from The San Francisco Chronicle
There are 2 sides to every coin, and the above article largely ignores this fact. It appears ot preach the absurd notion that it’s OK to borrow money you won’t pay back, while lying about your income and financial status at the time the loan was taken out. Additionally it infers that it’s OK to not take responsibility when you make a purchase to read the loan documents and make effort to understand what you are doing. Such absence of character is a large part what has caused the demise of the economic integrity of the United States. Those who are not willing to take responsibility for their actions and who are looking for someone to blame weaken the rest of us.
To be sure, many lenders have not paid their penance. They have delayed modifying or refused to modify loans that had terms that the borrowers could not live up to. The notorious Option ARMs and 2 year fixed mortgages are the most obvious. Both of these types of loans, whether intentionally or not, were marketed to the consumer without proper education and counseling. Neither of these products should have ever been combined with EZ doc and zero down, and the 1% option ARMS shoudl never have been made at all.
However, Subprime mortgages enabled many who previously could not qualify for homes to get into them. It also enabled many people in financial distress to get out of it by paying off and restructuring other debt. Presumably these people put that additional income to work by purchasing goods and services and stimulating the economy. The problems occurred when lenders put together loans with no documentation of income, coupled with marginal credit and limited assets or down payment. This extended the housing boom and caused housing inflation that could not be sustained. There was going to be a downturn anyway, but the extremely liberal lending requirement delayed the downturn and made it much worse.
Lenders are certainly not blameless, but it is also the lenders who are paying the biggest price for their miscalculations. However, to eliminate personal responsibility from the lending equation or any other equation is bad business.
On a finishing note, I am a complete believer that EZ doc loans have their place. These are for the self employed who have a significant down payment or equity position, outstanding credit, and cash reserves. Such loans will bolster the economy and allow the self employed to enter the pool of potential purchasers for all of these distressed properties. LL