Troubled homeowners choose strategic mortgage default
January 24, 2010 by dirkknudsen · Leave a Comment
By Amy E. Buttell, Cyberhomes Contributor
A Recently Sold Home in Portland, Oregon by Dirk and Todd Knudsen of Re/max Metro Gold
With one-quarter of all homeowners underwater and many unable to refinance, more are considering what was previously unthinkable: walking away from their homes, even though they can afford their payments. It’s an idea that’s gaining currency. Experian, a credit rating firm, and Oliver Wyman, a consulting firm, estimate more than 1 million strategic defaults occurred last year.
What is a strategic default?
A strategic default occurs when a homeowner who is able to make mortgage payments gives up a house without negotiating a short sale or some other type of deal with their lender. Many homeowners are considering such moves because their homes are worth much less than they paid for them, leaving them unable to refinance to a lower payment when their adjustable-rate mortgage resets. A strategic default may seem like an option worth entertaining before the interest rate increases, potentially making payments unaffordable.
How does a strategic default impact a homeowner’s credit rating?
Whether the bank forecloses on your house or you walk away, the impact is the same, says Craig Watts, senior national public relations manager with FICO, the creator of the FICO credit score. “A person’s credit report doesn’t include information about assets, income or the ability to pay,” he says. So a person or scoring formula that sees ‘foreclosure’ on the credit report doesn’t know why the borrower stopped paying, only that she or he did.”
Following a foreclosure, your credit score will plunge by as much as 160 points; consumers with higher credit scores will experience a sharper fall in their FICO score than a consumer with a lower score. “A homeowner’s credit score is going to suffer incredibly from walking away from a home,” says Alex Charfen, CEO of the Distressed Property Institute, a company that certifies real estate agents to help borrowers of distressed properties explore their options. “If they have a deficiency judgment claim, they are going to have a collections account on their record too, and that’s going to take a long time to recover from.” A foreclosure remains on your credit report for seven years. When a creditor makes a deficiency judgment claim for money you owe but haven’t repaid, it remains on your credit report as a collections item.
What are the other potential consequences?
A lot depends on whether you live in a state that is a recourse state or a non-recourse state. Non-recourse states don’t allow lenders to pursue consumers for amounts that are owed on mortgages above and beyond the value of the home; recourse states allow state to pursue consumers for such amounts. You can review a summary of state laws on this issue.
Even in recourse states, many lenders are so overwhelmed by foreclosures that they aren’t pursuing homeowners for any balance owned in excess of the home’s worth, says Frank Pallotta, executive
