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