Strategic Defaults aka the Nuclear Option: why burn your house down when you can just walk away and change your number

Ahh these people are great. Finally making the business decision that were previously reserved only for banks and the government. Ok, here's the deal: Credit scoring doesn't work. If it did, these people would have low scores not high ones. The other funny thing about credit scoring? It encourages MORE defaults. I mean come on, if you are going to have a foreclosure, you might as well max out all your credit cards and walk away from those as well. There is no such thing as slightly bad credit or not so bad credit just like you don't have a partial denial for a loan. It is good or bad. A foreclosure is going to tank your score like 200+ points instantly and you won't get approved for anything and all your issuers will start closing your accounts.

Now, apparently banks are not going to modify your mortgage if you have a high score and fit this profile. If you have high balances on your credit cards, they will cut your limit down as you pay it off, but if you have low balances with a lot of available credit, they'll cut your limits so you don't overspend, got it?

Want to join in the fun? Max out all your cards and wait for the 35-50% settlement offers to roll in.

Surprise! I've got good credit and I'll default just the same.

Reporting from Washington - Who is more likely to walk away from a house and a mortgage -- a person with super-prime credit scores or someone with lower scores?

Research using a massive sample of 24 million individual credit files has found that homeowners with high scores when they apply for a loan are 50% more likely to "strategically default" -- abruptly and intentionally pull the plug and abandon the mortgage -- compared with lower-scoring borrowers.

National credit bureau Experian teamed with consulting company Oliver Wyman to identify the characteristics and debt management behavior of the growing numbers of homeowners who bail out of their mortgages with none of the expected warning signs, such as nonpayments on other debts.

With foreclosures, delinquencies and loan losses at record levels, strategic defaults and walkaways are among the hottest subjects in residential real estate finance. Unlike in earlier academic studies, Experian and Wyman could tap into credit files over extended periods to identify patterns associated with strategic defaults.

Among researchers' findings are these eye-openers:

* The number of strategic defaults is far beyond most industry estimates -- 588,000 nationwide during 2008, more than double the total in 2007. They represented 18% of all serious delinquencies that extended for more than 60 days in last year's fourth quarter.

* Strategic defaulters often go straight from perfect payment histories to no mortgage payments at all. This is in stark contrast with most financially distressed borrowers, who try to keep paying on their mortgage even after they've fallen behind on other accounts.

* Strategic defaults are heavily concentrated in negative-equity markets where home values zoomed during the boom and have cratered since 2006. In California last year, the number of strategic defaults was 68 times higher than it was in 2005. In Florida it was 46 times higher. In most other parts of the country, defaults were about nine times higher in 2008 than in 2005.

* Two-thirds of strategic defaulters have only one mortgage -- the one they're walking away from on their primary homes. Individuals who have mortgages on multiple houses also have a higher likelihood of strategic default, but researchers believe that many of these walkaways are from investment properties or second homes.

* Homeowners with large mortgage balances generally are more likely to pull the plug than those with lower balances. Similarly, people with credit ratings in the two highest categories measured by VantageScore -- a joint scoring venture created by Experian and the two other national credit bureaus, Equifax and TransUnion -- are far more likely to default strategically than people in lower score categories.

* People who default strategically and lose their houses appear to understand the consequences of what they're doing. Piyush Tantia, an Oliver Wyman partner and a principal researcher on the study, said strategic defaulters "are clearly sophisticated," based on the patterns of selective payments observable in their credit files. For example, they tend not to default on home equity lines of credit until after they bail out on their main mortgages, sometimes to draw down more cash on the equity line.

Strategic defaulters may know that their credit scores will be severely depressed by their mortgage abandonment, Tantia said, but they appear to look at it as a business decision: "Well, I'm $200,000 in the hole on my house, and yes, I'll damage my credit," he said of defaulters. But they see it as the most practical solution under the circumstances.

The Experian-Wyman study does not try to explore the ethical or legal aspects of mortgage walkaways. But it does suggest that lenders and loan servicers take steps to screen and identify strategic defaulters in advance and possibly avoid offering them loan modifications, since they'll probably just re-default on them anyway.

The problem is so much more deeper than even this article indicates. Its not just people with good credit "choosing" to default. I would argue an abnormal number of loan applicants in CA and FL never went into the loan and then mortgage equity withdrawal phase with the intention of paying the money back. They knew when they were first purchased the home in 2005 through 2007 that the next step was pulling the down payment back out with some added profit.

The prospect of having bad credit, yet $700,000 to upwards of $3,000,000 in cash is a no brainer. Whenever I hear of billions of dollars earmarked for this and that mortgage bail outs, I laugh thinking of how quickly that money can get eaten up when home after home is $350K in the hole (with helocs taken into account.)

While we here on FWF were routintely expanding our credit lines from from $20K to $400K in the mid 2000s, others were quickly realizing the flaws in the FICO scoring, real estate appraisal, and nationwide lending mechanisms. If you put 20% to 30% down and had a strong FICO a $900,000 home in SOCAL was theirs to HELOC up to the millions.

Everyone is so focused on subprime, no money down, and no docs loans, that they are not noticing (or reporting) the strange high percentage of foreclosures on home that were initially purchased just a few years ago with 20% to 30% down payments.

Anywone who was involved in the Bankruptcy games prior to the changes in the law, knows the same thing was/is going on in SoCAL/NV/FL/AZ real estate. That why the blips on the screen indicating a turnaround are fools gold.

These were criminal acts that we all are paying for.

And the strategic default won't be nearly as bad if the mortgage is only in the name of one spouse.

solution= debtors prison.

The current credit system let people makes 100 of thousand of dollars as their homes were rising, and then when the market fell people who lost 100 of thousands of dollars can just bail. Essentially a 'low risk' way to make money if you really think about it...

tripleB said: I believe the underlying cause is due to a correlation between high business skills and high credit scores and a second correlation between high business skills and high "strategic" default rate. Thus due to the transitive property, a correlation exists between high credit score and high default.

I believe the underlying cause of your FWF posts is due to a correlation between your typing skills
and lots of free time, and a second correlation between lots of free time and the lack of a social life.
Thus due to the transitive property, a correlation exists between typing skills and the lack of a social life.

Believing that people picked up large amounts of debt in the mid 2000s with the plan to default on it in the late 2000s is giving the general public too much credit (pun and non-pun wise).

I agree with CN47 that borrowers should weigh a potential default like they would any other business decision. Ultimately, the question is how much value you place on your good (credit) name. There is a clear cost/benefit analysis that can be undertaken: the cost of poor creditworthiness for a number of years against the gain of not having to pay back money already borrowed. The financial institutions on the other side of the equation are not unsophisticated, and if they underestimated their default risk, too bad for them. They made a business decision to lend the money, often with insufficient or no collateral, just as some borrowers are making a business decision to not pay them back. It's just my opinion - one of many - but I don't recognize a moral imperative to pay back money lent in an arms-length transaction.

Now if only the government would allow these financial institutions to really feel the consequences of their stupid decisions. We will end up going through this again in a few years. Nobody has learned any lessons.

Would people still choose to walk away from a mortgage if that would be on their record permantently? If they'd never be able to get a decent rate on an auto loan again? Not be able to get a mortgage for another, say, 10 years (and then pay a much higher rate due to the BK history)? Have to put down 3-5x the security deposit when renting an apartment?

I think banks would be cutting their own throats. Banks lend money to charge interest to turn a profit. No lending, no profits, no big bonuses. Sure, you can gouge someone with some overdraft fees here and there, but all that does is piss people off and make them move down the street to get a free toaster. The thing is, nobody HAS TO get an auto loan. Nobody HAS TO get a mortgage. Nobody HAS TO use a bank for much else other than a safe place to stash cash.

Can't get an auto loan? Pay cash, buy used, and learn how to turn a wrench. Is the consumer really hurt by that? No. Are auto makers and banks that make auto loans? Yup.

Looking for an apartment? Save up and pay the full year in cash up front. I can't imagine very many landlords that would turn that down.

If you screw over your customers continually, you may find that you won't have any left.

sounds like my friend Ann

tester99 said: Why won’t the institutions just reduce principal, rewrite the loan

Ann had principal reduced (but by less than $50k only), interest rate reduced to 3%, still does default right now again. PITI was <= comparable rent!

Ann has plenty of cash and good income. A strategic default.

codename47 said: Would people still choose to walk away from a mortgage if that would be on their record permantently? If they'd never be able to get a decent rate on an auto loan again? Not be able to get a mortgage for another, say, 10 years (and then pay a much higher rate due to the BK history)? Have to put down 3-5x the security deposit when renting an apartment?

I think banks would be cutting their own throats. Banks lend money to charge interest to turn a profit. No lending, no profits, no big bonuses. Sure, you can gouge someone with some overdraft fees here and there, but all that does is piss people off and make them move down the street to get a free toaster. The thing is, nobody HAS TO get an auto loan. Nobody HAS TO get a mortgage. Nobody HAS TO use a bank for much else other than a safe place to stash cash.

Can't get an auto loan? Pay cash, buy used, and learn how to turn a wrench. Is the consumer really hurt by that? No. Are auto makers and banks that make auto loans? Yup.

Looking for an apartment? Save up and pay the full year in cash up front. I can't imagine very many landlords that would turn that down.

If you screw over your customers continually, you may find that you won't have any left.

I agree to some extent, but many of the people walking away are not the frugal, "living within their means" type. Some may be strategically defaulting (as the article indicates) and also able to weather a 7 year hit to their credit score. I would guess that these individuals are the minority and that many others who are defaulting do not save up large amounts of cash for things they need.

And there's no reason a bank or other financial institution would have to base rates on this information, but erasing history after 7 years seems to just be a bad idea IMHO.

I wonder if Chrysler's Jim Press is preparing a nuke ( see detnews.com ).

if you have income it can be garnished.
a bank account can be seized.

you can be held in comtempt and put in jail if you dont cooperate with the paper trail, or with debtors exams. do you really want to live off the grid?

you really have to know what you"re doing.

vitbich said: wp746911 said: solution= debtors prison.


debtor's prison = indentured servitude

Slavery is not the answer to foolish lending.

No, debt = slavery. No debt = free to pursue many opportunities not available to those in slavery.

if you have income it can be garnished.

-Not in every state. And besides, what do you do if there is already a garnishment in place scheduled to last for say 25 years?

a bank account can be seized.
-Sure, ones in your name...

you can be held in comtempt and put in jail if you dont cooperate with the paper trail, or with debtors exams. do you really want to live off the grid?

I don't think the only options are live off the grid or attend a debtor's exam. You can only be given an exam if you can be found, btw.

you really have to know what you"re doing.
True.

They cannot do jack with a non recourse loan. They cannot garnish your wages.

I've talked to friends in lending who say the normal wait for buying again after walking is 5-7 years. They all say that will be reduced when the bleeding stops to maybe 3. Are you hearing any new regulations making you wait to re-enter the market after a foreclosure?? They will need all these people back in the game. Were talking about people with assests, cash, jobs, probability of increased income. They will not let those people stay on the sidelines for long.

Foreclosure recourse in state of Florida.

If the house is given back during the Chap 7 bankruptcy there is no recourse because it gets wrapped in to the bankruptcy and usually discharged. I also don't think their is any foreclosure on your record either.

Seems funny that i never heard about this around here ...

Screw the banks.

You can give me whatever color you wish, or no color at all, or whatever you will, but they're the absolute poster children of reckless and irresponsible entities, with senior management structures comprised of the absolute poster children of reckless and irresponsible people (greedy beyond belief, too), half of whom wouldn't have a job, retirement account or any other assets (i.e. they'd be in dire straits) if it weren't for the command and control U.S. government appropriating honest Americans' taxdollars and shoveling them into the banking system.

I have zero empathy or consideration for the banks or the banking system.

JesseLivermore said: Screw the banks.

You can give me whatever color you wish, or no color at all, or whatever you will, but they're the absolute poster children of reckless and irresponsible entities, with senior management structures comprised of the absolute poster children of reckless and irresponsible people (greedy beyond belief, too), half of whom wouldn't have a job, retirement account or any other assets (i.e. they'd be in dire straits) if it weren't for the command and control U.S. government appropriating honest Americans' taxdollars and shoveling them into the banking system.

I have zero empathy or consideration for the banks or the banking system.

They are only irresponsible because the people they lent to are. Always easier to blame the large faceless banks right? The source of the problem has faces and families, its tough to tell them they the cause of their problems.

Stealing from the banks, insurance fraud....victimless crimes.

The unknown is how much a property will cost when you can buy back in. Florida and California markets move different but I cant see it going back to Bubble prices. What could trigger another run up in real estate? All indicators look to a flat market for some time.

"Always easier to blame the large faceless banks right"

Dont forget the large faceless rating agencies that labeled these securities along with the other usual suspects.

kenmoreland said: tripleB said: I believe the underlying cause is due to a correlation between high business skills and high credit scores and a second correlation between high business skills and high "strategic" default rate. Thus due to the transitive property, a correlation exists between high credit score and high default.

I believe the underlying cause of your FWF posts is due to a correlation between your typing skills
and lots of free time, and a second correlation between lots of free time and the lack of a social life.
Thus due to the transitive property, a correlation exists between typing skills and the lack of a social life.

lolol

I love it.

Article today on CNN.com about banks pursuing borrowers for deficiencies in foreclosures and short sales, not a big deal if you live in a non-recourse state, but make sure you do the legal homework for your state before thinking this is just a credit hit and can't affect your bottom line.

"Strategic Defaults

Sometimes lenders go after borrowers walking away from their homes if they have other assets, according to Florida real estate attorney Larry Tolchinsky.

"Banks are pulling credit reports to see if it's a strategic default," he said. "If you're behind on all your other payments, you're okay. But if you're not, they'll come after you.""

http://money.cnn.com/2010/02/03/real_estate/foreclosure_deficien...