Are You Likely to Walk Away From Your Mortgage?
A leading credit bureau partnered with a management consulting firm to figure out who is strategically defaulting and how lenders can get a better handle on risky borrowers. Experian and Oliver Wyman found that in the first half of 2009, 355,000 homeowners strategically defaulted, which is a 53 percent increase over the same period in 2008. (These statistics were included in the conclusions of the Q2 2010 report, "Understanding Strategic Default in Mortgages.")
The researchers define "strategic default" (or "walk-away") as a "default behavior in which the borrower has the ability to make monthly payments on his mortgage, but chooses not to do so, most likely for reasons of negative equity."
So what are the key characteristics of a strategic defaulter?
- Investors with more than one mortgage show a higher rate of default. The researchers found that borrowers with more than one mortgage stay current on at least one mortgage 80 percent of the time. They most likely stay current on their primary home.
- The number of strategic defaulters with just one mortgage is growing. In fact, 68 percent of strategic defaulters only had one mortgage in 2009, which is 4 percent higher than 2008.
- Strategic defaulters are more likely to be creditworthy borrowers. They qualified for the mortgage with a VantageScore of 901 to 990, which is "super-prime" according to Experian's ranking. The researchers found these borrowers to be "financially savvy and capable of realizing the cost of continuing to hold an underwater mortgage."
- Strategic defaulters are approved for high loan-to-value mortgages and so they are likely to be deeply underwater in the current market.
- About 50 percent of strategic defaulters stay current on their home equity lines even after they defaulted on their mortgage. This is opposite of a defaulter-in-distress. Defaulters-in-distress are more likely to default on their equity line first.
Researchers also concluded that it's important for lenders to identify the strategic defaulters because they are more likely to "take advantage of the loan modification programs, trying to stay in their homes as long as possible while making as few payments as possible." They found that they are likely to re-default and abuse the programs.
Strategic defaulters are located primarily in states in which homes lost significant value. For example, walk-aways in California were 80 times higher in the first two quarters of 2009 compared to 2005. Florida shows a similar trend, but strategic default is not growing as quickly in Florida. One key difference is likely that Florida is a state that allows lenders to chase defaulters for any shortfall. California does not.
The types of borrowers the researchers identified that could be helped by modification were categorized as "cash flow managers" and "distressed defaulters." Cash flow managers are likely to be in temporary distress, but have the money to pay non-mortgage obligations. A loan modification may help them get back on their feet with more affordable mortgage payments. They tend to miss payments but will also make payments periodically after default. Strategic defaulters don't do that. They abruptly stop making payments and go straight to foreclosure.
Distressed defaulters are likely people who lost a job or facing some other type of distress. They need more aggressive help and may not be able to avoid foreclosure. The new Home Affordable Unemployment Program (HAUP) may be the answer for them.
Lenders need to categorize their borrowers and quickly identify the strategic defaulters. In fact, Fannie Mae made it clear that it plans to crack down on strategic defaulters, while easing up on others. If you don't work with your lender and just walk away, Fannie Mae will block your ability to get another mortgage for seven years. People who work with their lenders may be eligible for another mortgage in two to four years. In addition, Fannie Mae is encouraging lenders to try to collect any shortfall on the amount due from the mortgage, if the state allows them to do so.
Lita Epstein has written more than 25 books including "The 250 Questions You Should Ask to Avoid Foreclosure" and "The Complete Idiot's Guide to Personal Bankruptcy."
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