At the height of the Great Recession, homeowners who defaulted on their mortgages were painted as villains — selfish and immoral. The general thinking was that most of these homeowners chose to default in the face of plummeting home values, even if they had the capability to make payments, called strategic default. However, the Federal Reserve Bank of Boston recently published a paper that refutes those assumptions, and challenges the way lenders ought to weigh mortgage risk.
The paper studied 5,300 households which defaulted for the first time in 2009-2011. Researchers found that when a head of household lost their job, they were three times more likely to default than before the job loss.
Other factors that increase the likelihood of mortgage default include:
- significant medical expenses; and
- other financial shocks.
However, while these financial losses increase the likelihood of default, those experiencing these types of financial shocks by and large still do not default. In fact, over 80% of households affected by unemployment and with less than one month of mortgage payments set aside in savings stayed current on their mortgage during this time, despite the hardship.
More significantly, only 40% of those who defaulted were actually aware they were underwater on their mortgage.
The takeaway: strategic default is rare, and in most cases struggling homeowners with limited ability to pay by and large continue to make payments on their mortgage, regardless of underwater status. This contradicts other studies conducted in recent years, but the researchers are confident of their findings since they take in the complete picture of each former homeowner’s finances, rather than basing it on the lender’s perception of homeowners’ ability-to-pay.
Fast-forward to 2016
The default and foreclosure crisis following the 2008 recession was long ago. What does it have to do with today’s real estate market?
The next couple of years are likely to see an uptick in mortgage defaults. Don’t expect this to rise anywhere near the heights experienced during the recession. Still, as home equity lines of credit (HELOCs) and Home Affordable Modification Program (HAMP) mortgages are increasingly reset in 2016 and 2017, expect to see more defaulting homeowners as they are unable to keep up with new, higher payments.
Another reason you may see more defaults in the coming months: personal bankruptcies tend to jump at the tail end of an economic recovery. This occurs as many homeowners give up waiting for their home to amortize into positive equity status, and throw in the towel. Home prices are expected to dip in 2017 in reaction to higher mortgage rates, and that’s when the bump in bankruptcies will likely occur.
However, this rise in defaults and bankruptcies will be a small bump in an otherwise expanding economy and housing market. As the study claims, most homeowners choose to remain chained to the black hole asset that is their underwater home, even when it’s difficult to make payments. Therefore, instead of looking to underwater status as the number one indicator of default, look first to unemployment and other financial factors.
Agents: direct past clients seeking to evade default due to financial distress to foreclosure avoidance programs. Keep Your home California is one such program. Or, point them to a California real estate attorney to go over all the options.