Strategic Default | Not a Good Idea? (or "Damned if You Do…")

So you find yourself in a none-too-fun position: your home’s value is less than the balance on your mortgage.  You are still able to make the monthly mortgage payments, but you simply want – or NEED – to get out from underneath this bad/financially “upside down” situation…

From this Bloomberg article on strategic defaulting, Morgan Stanley estimates that 12% of the mortgage defaults in February 2010 were what are known as “strategic defaults.” These are situations where people simply decided to walk away from their mortgage obligation without making any reasonable effort to modify or otherwise restructure their loan, but still have the financial ability to pay the monthly mortgage.

Now, Fannie Mae, the mortgage guarantor of nearly half of the $10.7 trillion U.S. mortgage market, is dropping the hammer on these “strategic defaulters.”

Seven Years

Fannie Mae recently indicated that they will refuse new mortgages for strategic defaulters for seven years from the date of default.

From the Fannie Mae press release:

WASHINGTON, DC  Fannie Mae (FNM/NYSE) announced today policy changes designed to encourage borrowers to work with their servicers and pursue alternatives to foreclosure. Defaulting borrowers who walk-away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure. Borrowers who have extenuating circumstances may be eligible for new loan in a shorter timeframe.

“We’re taking these steps to highlight the importance of working with your servicer,” said Terence Edwards, executive vice president for credit portfolio management. “Walking away from a mortgage is bad for borrowers and bad for communities and our approach is meant to deter the disturbing trend toward strategic defaulting. On the flip side, borrowers facing hardship who make a good faith effort to resolve their situation with their servicer will preserve the option to be considered for a future Fannie Mae loan in a shorter period of time.”

What Does It All Mean?

Mike Konczal, a fellow at the Roosevelt Institute and former financial engineer, has a seriously great analysis about the Fannie Mae initiative.  The short of it, for anyone considering a strategic default, is that there really isn’t a simple, straightforward answer.  Nor is there a simple solution, either.

If you decide to strategically default on your current mortgage, you will likely be barred for seven years from obtaining a new mortgage.  Not a fun position to be in, but that’s the current real estate reality.  The other option is to stay in your home and continue to make those payments.

But how long would it take for you to get your home’s equity back to even?

Mike’s blog has an analysis that shows that to get your home’s equity back to even will likely take eight to twelve years…

So, truly, “Damned if you do, and damned if you don’t.”

If you’ve got questions about your current housing situation, give us a call or simply click the “What’s my home worth,” button below, drop your information, and one of our agents will be in touch with you.

0 Responses to Strategic Default | Not a Good Idea? (or "Damned if You Do…")

  1. Seems to me there’s no “Damned if you do, damned if you don’t” choice here, unless you try REAL hard to find one.

    Anyone who is going to walk away from a mortgage to preserve cash is unlikely to be thinking of buying another house within 7 years anyhow. Should the market turn so much that such a person is thinking of buying again, chances are better than even that private financing would become available.

    Of course, how Fannie Mae continues to justify taking taxpayer dollars for bailout after bailout while refusing some taxpayers, who are doing nothing illegal (if their mortgage agreement allows them to walk away, they’re doing nothing illegal), mortgages is going to be a political question in the not-too-distant future. The excuse that “we’re just taking creditworthiness into account” rings hollow for a company taking tens upon tens of billions from the American taxpayer.


    • Rob, agree with you completely. At some point all foreclosures are “strategic.” A family reaches a breaking point where the consequence of a foreclosure is less the than the consequence of trying to keep all the balls in the air. How do you think they will discern a “strategic foreclosure” versus a “righteous foreclosure?” Debt to income ratio? Negative net worth? Seems like a slippery slope.

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