Posted on: Monday, January 11, 2010

Strategic Default?

By Paul M. J. Suchecki
Tags: Falling Home Value, underwater, ...
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One of the most significant factors in mortgage delinquency is whether or not a home is underwater. Some like University of Arizona law professor Roger Lowenstein in yesterday’s NY Times Magazine are now urging that these distressed borrowers simply walk away from their homes in a so called strategic default. This plan of action is wrong in a number of ways.

Houses are much more than investments. We are shaped by our environments especially our homes. The first question to answer if you are behind on your mortgage is the simplest. Should you stay or go?  Draw up a checklist with two columns. On one put all the reasons for staying, the other for going. To begin with answer the following questions:

• Do you like your neighborhood?
• Is your commute convenient?
• Are your children in good local schools?
• Is you’re your house filled with the amenities that make life worthwhile?
• Is there enough space?
• Are your energy bills affordable or out of control?

With your partner add any other questions that matter. Next weigh each of these issues and their significance. If your single child has one year left at your town’s high school, that factor should weigh less in your decision than if you have four children in a local grammar school. Add up the weighed tally on each side of the issue, and you have an objective starting point for further evaluation.

If you do decide to stay, MortgageOureach.org is chock full of steps you can take to save your home, from refinancing, to loan modifications, to guides to lender, US government and state assistance. You do not need to pay for help. For knowledgeable credible aid, start by contacting a US Department of Housing and Urban Development, HUD, approved counseling agency.

If you decide to leave, try to arrange a short sale where the bank accepts less than your mortgage is worth. Next, see if you can swap keys for cash, which will be helpful on getting enough together for a rent deposit. Rather than drag the process out, a cleaner way of leaving your home is giving up your deed in lieu of foreclosure. Remember, don’t take this step lightly because bailing out of a home loan while your place is underwater will lower your credit score.

Strategic default as advocated by some is irresponsible gaming of the system. You would be able spend less money by simply hanging tough and ignoring all notices sent to you until you are put on the street by the sheriff, but there are other factors to consider.

First is the damage you’ll do to your credit report. Negative items like foreclosure stay on your report for seven long years. Foreclosure is one of the worst. Unless you already have credit cards, it will be nearly impossible to get a new one for the foreseeable future. Have you tried to rent a car or buy something online without a credit card? These little pieces of plastic have now become vital to modern life.  In many cases you probably won’t even be able to get any kind of loan unless you approach the sharks at payday advance centers. Yes, you will still be able to finance the purchase of a new car, at an outrageous rate 0f 16% and up for a secured loan. If you still have credit cards, expect any outstanding balances to be boosted to exorbitant interest as your perceived risk of defaulting increases since all credit card issuers now run reports on current customers. When considering a strategic default, take into account the increased interest charges you’ll pay on anything that you finance for the next seven years, when that negative item credit will finally be erased.

Unemployment is another cause of default. Just as the economy is about to add jobs, why hurt your personal marketability? Many employers these days are running credit reports on prospective employees. All things being comparable, having a foreclosure on your record will knock you lower on any new hire list. If you’re applying for any work in business management, a foreclosure will shoot your credibility full of holes.

Unless you plan to move in with family or friends, you’re probably planning to rent after leaving your home. Landlords are now routinely running credit reports as well. If one is even willing to rent to you after a foreclosure, expect far larger security deposits, tough to come up if you are financially strapped. Too many dispossessed former homeowners end up in motels, often a short step before the streets.

A foreclosure may not be the end to your financial obligations. Most states allow lenders to go after any of your other assets through deficiency judgements.

Finally, how long will your home actually remain underwater? One lurking economic issue is the prospect of inflation. The US is deeper in debt than ever with a weak dollar. Inflationary pressures are building and will be unleashed as more people resume work. Traditionally, tangible assets do well in times of inflation. Housing was at the core of the recent investment bubble, which is why it tanked, but it will come back. In some communities you can readily find houses where the paper value is less than its replacement cost, an anomaly that will ultimately reverse.

As former Treasury Secretary Henry M. Paulson Jr. puts it, “Any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator — and one who is not honoring his obligation.”

When you bought your home, nobody guaranteed that its value would continue to increase exponentially forever. However, when you signed your mortgage, you agreed a contract. There is more at stake with a mortgage than your own personal obligation; there is a social contract involved. When you bought your home, you joined a community. A foreclosure not only harms you, it impacts your neighbors. Malcom Gladwell wrote an excellent book called The Tipping Point about how small events can have a cascading social effect. Foreclosures have had huge impacts on neighbors left behind. In some hard hit areas home values have declined across the board, local businesses have shuttered and crime has increased.

Sometimes it’s tough to do the right thing, like honoring your commitments, but most of us try our best to do so.