A recent article by Ken Harney at the LA Times cited a study done by Experian (one of the 3 major credit reporting bureaus) that highlighted some very interesting information about foreclosures. Think foreclosures only happen to people with bad credit? Think again!
Traditional thinking indicates that foreclosures happen to people who are “down on their luck”, maybe they lost a job, maybe they got sick or maybe they were careless, overspent and are getting foreclosed on because they are in over their heads. There is typically a pattern that appears in their credit history, late payments, missed payments delinquencies on other debts. A growing trend over the last few years has been contrary to this pattern. People with great credit scores and no other “warning signs” or “life changing events” such as a job loss are being foreclosed on in record numbers.
The study done by Experian looked for answers to that question and using data from 24 million credit that they were able to review over time to look for patterns, they found some interesting trends. Here are some of the things they found:
- 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.
Also, the study found that people with high credit scores at the time of loan application are 50% more likely to strategically default than people with poor credit scores.
So what does it all mean, who is doing this? Well, for starters, there are some people gaming the system. They bought to high, they speculated, they bled out their equity and now rather than make good on the debt they are just walking away, kinda like stealing. Then there are people who legitimately intended to make good on the debt, had wanted to build equity, own a home, live the dream. These people, as the survey indicates, are typically in markets where there is a significant amount of negative equity. They have no missed payments, no problems making payments, they just take a hard look at their situation, decide that they will never recover the loss in equity (buying a home for $400,000 and it being only sellable for $200,000 and yes, in California and Florida that really happened) and just walk away. They know their credit will be damaged and here is the problem with this whole scenario, why walking away is more attractive than sticking it out and making good on their debt: in 3 years, if they treat their credit reports right and rebuild those scores, they could get a brand new mortgage on another home.
There are many legal implications here that I won’t go into since I am not a lawyer, walking away does not always make the debt go away. Let’s not forget either the ethical problems associated with taking a mortgage, promising to pay it back and then just breaking your word and walking, there by making the rest of us pay for it in higher interest rates and bail outs, but let me ask you, is a strategic default right or is it wrong? If you were in this situation, what would you do?
I’d like you to be part of the conversation here, so please, comment, forward this to your friends, subscribe and as always, if you have questions, need real estate advice or want to buy or sell a home, you can call or text me at 717-371-0557, email me at Jason@JasonsHomes.com or contact me at the office at 717-490-8999!
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