Walking Away From Homes Losing Appeal?

Strategic defaults may be falling out of favor
Strategic defaults may be falling out of favor

Now that the housing market is bottoming out in many areas of country and even showing some signs of recovery, is strategic default a passing phase or still worth considering? The San Francisco Federal Reserve concludes that the default point "depends on a borrower's expectations regarding future house price changes and perceived default costs." If we are now on the road to recovery, more homeowner's are likely to wait to see what happens to the market rather than default.

The Fed found that "The possibility of price appreciation and the costs of default move the rational default point well below the underwater mark." Even someone sitting on an adjustable-rate mortgage that is underwater and due to reset will likely stay in their home because the "cost of maintaining the option by not defaulting is low."

The Fed believes the rational borrower will wait as long as possible before the reset to make the decision about whether or not to default. They will wait to see what happens to house prices. "On average, borrowers wait for prices to decline further before deciding to default."

That's because it's a "heads-I-win, tails you lose" situation "vis-a-vis the lender." If the house price falls further, the borrower can still decide to default, which means a further loss to the lender but no additional cost to the borrower. if the house price recovers the borrower gets the full advantage of that recovery. So the Fed concludes, "With both upside potential and downside protection against future losses, the borrower rationally should wait before defaulting."