Mortgage Walk-Away Not Favored, Even by Borrowers in Need

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You probably won't be surprised to learn that the key reasons people just walk away from their homes involve job loss and a significant drop in home value. What might surprise you is how long people hold onto their homes before they decide to walk away.

The Federal Reserve found in a recent study that most strategic defaulters don't walk away from their home until the equity in their home is negative 62 percent of the home's value.
The Federal Reserve considers strategic defaulters people who miss six straight mortgage payments, but continue to pay their auto loans and other consumer debts on time. The Fed focused on four states where property values fell dramatically since 2006 -- Arizona, California, Florida and Nevada. They looked specifically at people who bought their home in 2006 using non-prime mortgages with 100 percent financing. By the end of September 2009, 80 percent of these borrowers defaulted on their mortgages.

The Fed then looked to separate defaults caused by job losses and other income shocks and those they just gave up paying the mortgage because of the drop in their home's value. They found that the median borrower does not strategically default until equity falls to negative 62 percent of their home's value. Ultimately the Fed found that 80 percent of defaults in the sample ended up in default because of a combination of job loss and negative equity.

They found that while people who lose their job and don't have negative equity can sell the property and get out of a bad debt situation, those with negative equity don't have any choice but to default. They call this the "double-trigger" hypothesis. "Borrowers do not ruthlessly exercise the default option at relatively low levels of negative equity," the study author's wrote. "However, when equity falls below -50 percent, half of the defaults are driven purely by negative equity."

Another key difference the researchers found is whether or not the home owner lives in a state that allows recourse, which means the lender can chase the borrower for any shortfall after a foreclosure. Florida and Nevada allow recourse, while California and Nevada do not. Borrowers in Florida and Nevada waited until their home's value fell more steeply -- about 20 to 30 percentage points more underwater -- before strategically defaulting. California had the highest rate of strategic defaults, and it jumped nearly 80 times higher in the first two quarters of 2009 versus 2005.

A borrower's FICO score also seemed to be a factor in the decision to walk away. The median borrower with a FICO score between 620 and 680 walks away when equity hits -51 percent, but someone with a FICO score about 720 will hold on to the property until negative equity hits -68 percent.

Since this study looked at borrowers who put nothing down, the Fed realizes the findings may not translate to borrowers who put more money down. They suggest that this may not translate to other borrowers who "likely invested more financially and emotionally in their house." They may be willing to wait even longer before considering strategic default, but that still needs to be studied.

Fannie Mae turned up the heat last week on those who choose to strategically walk away. They lowered the waiting time for buying another home if you work with you lender and raised if for those who just walk away. You may be able to get another Fannie Mae mortgage is as little as two to four years if you work with your lender, but you'll need to wait seven if you just walk away.

Lita Epstein has written more than 25 books, including "The 250 Questions You Should Ask to Avoid Foreclosure."

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