"The American consumer has had a long-held taboo against walking away from the home, and this crisis seems to be eroding that," concludes a report on research by Experian, the credit agency, and Oliver Wyman, a management consultant company.
The better their credit rating, the more likely homeowners were to default. The trend is most pronounced where prices have fallen furthest: Florida and the West, especially California.
The finding -- that 588,000 borrowers appear to have strategically defaulted in 2008, a 128% increase from the year before -- surprised the researchers. Piyush Tantia, who conducted the research for Oliver Wyman, and Charles Chung of Experian spotted the trend while analyzing 24 million credit files to see what they could learn about mortgage delinquency.
Foreclosure as a financial strategy
Strategic defaulters stand out among the 14 million to 15 million "underwater" mortgages, the researchers said, because they:- Pay all their bills consistently and on time until abruptly stopping mortgage payments with no attempt to get current again.
- Keep current on other debts after defaulting on the mortgage.
- Keep up payments on home equity lines of credit, sometimes drawing out cash, before defaulting on both the first mortgage and credit line.
This "sophisticated" combination of moves and timing suggests borrowers are employing foreclosure as a calculated financial strategy, said Tantia and Chung.
They conclude that 18% of the borrowers with mortgages 60 days past due in the fourth quarter of 2008 were acting strategically, up from 3% -- "barely noticeable," the report says -- in late 2004. Most defaults, however, are driven by financial distress. Defaults due to troubled finances grew from 31% to 51% of loans in the same time frame.
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Broken taboo
It appears that the more money people feel they're losing, the more likely they are to bolt. Owners with smaller loans were less likely to strategically default, even when facing the same percentage of loss.For example, "once you hit the $200,000-and-up loan size in California, you start to see about 33% strategic defaults," said Tantia. A similar pattern, with 18% to 20% strategic defaults and lower loan amounts, plays out in the rest of the country: "This tells us that the threshold probably is a dollar value and not a percentage."
From 2005 to 2008, strategic defaults rose by 68 times in California, by 46 times in Florida and by three to 18 times in other regions. Strategic default was seven times more common among mortgages originated in 2006 than those begun in 2004.
"Starting about a year ago, the good-credit people, the Little League coaches, the schoolteachers and the retail managers, the higher levels, started walking away," says Kurtis Squyres, whose company, FarBelowMarket.com, buys homes in the Coachella Valley east of Los Angeles that banks have foreclosed on and sells the properties to investors. "I even had a DA who had talked about it. He was very seriously considering buying another house because his credit was still intact, and then walking. His conscience got the better of him, but that shows how tempting it is."
Makes sense to some
Strategic defaults may sound cynical, but such calculations are becoming familiar to real-estate professionals. The word is that "your credit will heal before you recover what you borrowed against it," says Squyres. The alternative, a short sale, is difficult, lengthy and uncertain of success, he says.
Video: Give up or pay up?Even if true, strategic defaulters face a long sentence in credit hell: It takes seven years plus 180 days from the date of the first missed mortgage payment for a foreclosure to exit your credit record, says Liz Pulliam Weston, an MSN Money personal finance columnist.
"Your credit scores start getting trashed the minute you miss a payment. The more payments you miss, the worse the damage," says Weston, the author of "Your Credit Score, Your Money & What's at Stake." "The effect on your scores diminishes over time if you handle credit responsibly from then on."
Almost certainly your score will fall into subprime territory, a FICO score of 620 or less. "I know one real-estate investor with multiple foreclosures whose score fell to 305 -- just above the absolute bottom," Weston says.
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