Homeowners With Good Credit Are More Likely To Strategically Default
Here's an interesting discovery about mortgage defaults from the LA Times:
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.
These strategic defaulters tend to know the consequences of walking away, and they tend to live in "negative-equity markets where home values zoomed during the boom and have cratered since 2006." To them, it's a business decision and the best of a range of bad options. One consequence of the study, however, may be that lenders won't be as willing to offer loan modifications to borrowers who fit the profile, as they'll possibly still walk away at some later date.
"Homeowners who 'strategically default' on loans a growing problem" [LA Times]
(Photo: dingbat2005)
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So now a good credit score is bad and having a bad score is bad and having just an ok score won't do much more than get you a car loan. How are we supposed to buy houses again?
This isn't surprising, is it? People who have higher scores are usually more financially savvy, therefore, they're most likely to employ a financially savvy option (strategic default in this case). I guess the point of research is to find out if things we think are true or false, but can we start with the less obvious stuff first?
What do they consider high? Is this why I'm having trouble refinancing with a credit score over 750?
This simply means the strategy for "strategic default" will change. Rather than going from full payments to no payments, these borrowers should emulate the behavior of the lower credit score borrowers to escape the economic-profiling of banks.
But whoda thunkit - people with good credit scores make business decisions instead of emotional decisions regarding money. I guess that's what research is for - to prove what is common knowledge.
wouldnt this only really apply to people that purchased thier home towards the end of the growth, when prices were at the highest. if ive paid into a home for 20 yrs and it suddenly lost a little value i dont think i would default.
Maybe the people with good credit that pay their bills are getting sick of watching those that don't get rewarded.
I would assume that these defaults had little or no money down and have not lived in the property long enough to build up equity. However, I hope they have another place to live since it doesn't look like they will be able to buy for awhile.
Once banks broke the social contract by turning into loan sharks wearing starched shirts, can they really complain when their customers break their side of the bargain on a strictly dollars-and-cents basis?
Be careful of unintended consequences, bankers.
@firemunkie: They do say it's more likely with a high mortgage balance than a low one, which is a numbers way of taking time in the house into consideration.
@Trai_Dep:
Be fair - banks are responsible for coming up with risky loans and the derivitive securities that allowed them to loan so freely. Appraisers, builders, and R/E agents share blame as well. They not only influence the flow of buyer's to neighborhoods but also help determine the "value" of the property.
Exactly. It's called having no skin in the game. If they HAD skin in the game, you'd bet your booty they'd not default.
Tell me how the silly 3% down FHA loans are going to help this situation again?
Of course the math geniuses at Fair, Isaac Co. think they're so smart...until human behavior unpredictability zings them.
Lies, damned lies and statistics! The LA Times article is written in a way that suggests that most defaults are strategic defaults: "...50% more likely to strategically default..." without saying until 3 paragraphs later that strategic defaults represent 18% of "serious delinquencies over 60 days in last year's fourth quarter."
I'm not suggesting that these strategic defaults are inconsequential, but it sure seemed like they're saying most defaults are intentional until you get deep into the article.
They're more likely to "strategically default" - make a conscious decision to do so - because they are far less likely to actually be forced to default. Conversely, when those with lower scores default, it wasn't strategy, it was necessity - they actually couldn't make their payments.
I would guess that these are people who need to relocate for some reason and do not see a gain by continuing to pour money into a losing proposition. Say you buy a $300,000 home in 2007 and are transferred or relocate for work in 2009. The value of your home is now 30% less than when you boought it. Your choices are 1) continue to pay the mortgage as the value falls, 2) try and do a short sell on the home, 3) do a deed in lieu of Foreclosure, or 4) let the home be foreclosed upon. The hit you take on your credit is nearly the same for 2 and 3, and not much worse for 4. Obiviously paying the mortgage is the best bet on your credit score, untill you look at other factors. If you had a mortgage of near $2000 a month (possible with 100% financing) and can not sell your home for years years because of devaluation, you will pay $24,000 per year plus maintenaince to keep your credit score high. If it take five years to recover the lost value of your home, that is about $120,000 you paid, so you kept a good credit score, and did not lose $100,000. Now if you do 2,3, or 4, you will be able to buy again in two to four years. Financially, it makes sense to walk away or sell it short. Ethics are a different matter, and a different discussion.
When I was taking my driving test, I realized I had bumped a cone while doing the three-point turn. I knew I'd lost a point, and that I'd lose another if I adjusted my trajectory, possibly a third if I hit another cone on the reentry.
So I WRECKED the cone to complete my turn, plowed right through it. Took my one point deduct and went on to pass. If I'd readjusted and behaved like a responsible human being, I might have had to retake.
It's not the same thing, but I'm just sayin'.
@reservoir_dog: Is it that they're less likely to be forced to default, or that they realize forced default would be inevitable and wish to preserve everything they can? I'm thinking it's the latter--they're just choosing the time and condition of the default so that it's less deleterious to them.
@rickinsthelens: This is almost the same position I am in. I relocated for a job in 2004 (from Michigan to Texas) and the housing market has continued to die up in Michigan the longer I am down here. For a long time I had someone put renters in my house up north - now that company has gone out of business. The house has lost about 40% of its value since I purchased it in 2001.
I have a (primary) home/mortgage here in Texas so letting the house foreclose won't impact my living arrangements for the time being. It is going to devastate my credit (which I just "fixed" by getting out of tons and tons of CC debt), but what's the option - still pay on a house that is bleeding money?
Anyway, this line in the post really spoke to me:
"One consequence of the study, however, may be that lenders won't be as willing to offer loan modifications to borrowers who fit the profile, as they'll possibly still walk away at some later date."
I have had a hell of a time getting Chase to review/modify that loan even after my husband was laid off and we are now a single income home. They said I can afford two houses (and two car payments) on my income (hint: I can't). Is it because my credit is generally strong, besides the 9 months of missed payments on the Michigan house?
It makes sense. Trash one aspect of your finances to save the others. I'm not gonna blow through all my savings, just to keep current on a home that's 50% underwater.
Walk away, save your money, pay all your other bills, and live to fight another day!
Damned if you do and damned if you don't. So having good credit will be just as suceptible as having bad credit. Consumers can't win (but the banks always do).
@floraposte: Good point. I guess I'm considering the scenario of inevitable forced default as run of the mill forced default - one could bail early if you knew where the bridge ended.
@rickinsthelens: Well there is no problem with ethics at all.
The bank loans money based on the value of the home. If something happens and you can't pay the bank gets the home. It's the banks job to ensure that they haven't given more money to you than the home is worth.
If the value of your home went from $100,000 to $1,000,000 and you were 95,000 paid off but 6 months late on your payment the bank would likely foreclose on that.
@jaydez: I had no problem getting a mortgage (just received final commitment from the lender). The process was more rigorous than when I last applied (in 2002), but I have excellent credit (about the same as what you mention). The question is what percentage of the ACTUAL value of your home are you looking to refinance? Property values have tanked. I sold my condo for less than what I paid for it. If you're not able to maintain 20% equity in the home, even with a refinance, they might not be willing to make the loan.
In essence, why throw good money after bad is the message here. Your credit score might take a dive of 100-200 points but you could be saving $10K a year plus. Then you can take the savings and use it as a down payment.
One of my good friends, a professional with a good job who bought a home in 2007 has decided to stop paying her mortgage so she can get a modification. She could continue to pay the mortgage, but she figures why should she when she can get her interest rated knocked down to 3% or she can get the mortgage amount knocked down to what the house is now worth, $100,000 less than what she paid for it. She has plenty of money, enough to pay upkeep for a horse she owns and lots of other perks, but because she is self employed she can also hide a fair amount of that cash so it won't appear that she has many resources.
I live in Florida and I invest in real estate so yeah I've got some properties that are up side down. I even have one property that I'd love to walk away from or give back to the bank, but I couldn't do it even if I could do it, I invested in real estate it was my choice (along with Mr. Sam) and guess what the investment has tanked. We are hopeful that eventually the market will go up and we can sell these properties according to our original plan (or a modified original plan) but if we can't or we have to sell them at a loss we'll sell them at a loss take our tax write off and move on. It was an investment and not all investments work out.
Well what makes the whole thing more sticky is if you have PMI on your loan. Apparently PMI technically is only forced to pay out on a default. So if you're trying a short sale, or a DIL to get out of your house the PMI company will often come back and say no, we won't pay on that, or at least come back and ask the borrower to pay a large portion of their loss. So if you have PMI and want to dump the house the only option is often default. It ends up being in the bank's interest to force the default rather than take the short sale or DIL. So again, the banks will always do what is best for them financially. I have no issue people doing what is best for them financially on the other end of the transaction.
This is great because it's both counterintuitive and perfectly unsurprising at the same time. Borrowers with higher scores are likely to be more financially savvy than the average joe. Due to a confluence of factors, strategically defaulting increasingly become the more financially savvy thing to do, with the social "stigma" of bankruptcy lessening (everyone's doing it!), tricks (borrowers in good standing buy another home at cheap present prices, then default on their underwater mortgage; their credit takes a hit, but they're in another home and not planning on buying another home for 7 years) and given the high scores, the willingness to make financially difficult decisions.
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@jaydez:
Yes as chiieddy said right now it's mainly about 2 things: Loan-to-value (LTV) and debt-to-income (DTI). Credit scores still matter but not more than those other 2 things right now.
@GeorgeO:
This is why banks need to stop offering no recourse mortgages! If your area is dumb enough to mandate them, just stop offering mortgages there, period. Make homeowners take out a line of credit, instead.
It's totally idiotic that you could walk away from the mortgage of a house with large amounts of cash still sitting in the bank.
@treimel:
And by the same token, the strategic defaulters are living up to the terms of the mortgage as well. Nobody has broken their side of the bargain here.
I might become one of the strategic foreclosures. My house is worth about 2/3 what my mortage is, and it's in an older neighborhood of the town I live in. Plus, a new subdivision right next to me has been approved, so value isn't going up any time soon. My mortgage was just sold, so I'm sure the new administrator won't want to work a deal with me immediately. Might just start putting my mortgage money in safe deposit box and wait for them to work with me or else have a good bit of cash stashed away for a deposit on a rent to own house.
@firemunkie: Yes, because the person with 20 years of payments generally has quit a bit of actual equity. If you bought a house for $500,000 last year and now you can only get $350,000/$400,000, you will really lose money over 15-30 years. It's now a bad investment. Bail out now before you invest more real money in it.
@reservoir_dog: They will probably buy their new home first, with minimal down, default the first, then they can use the payments on the first to help pay the second.
I kind of wish we'd done this. Instead, when we were transferred out of state we had to borrow $60,000 from family to sell our house and pay our mortgage. We did that for stupid personal responsibility reasons. Now, by the time it's completely paid off, the foreclosure would have been off our credit score and we'd have $60,000 in savings instead.
@Hooray4Zoidberg: My understanding is that these folks will rent for a couple years, then buy and take a hit on the interest rate, and refi after another 5 years when the foreclosure drops off their record. Having bad credit won't keep you out of a house, it'll just keep you from getting the best interest rate and lowest down payment, right?
Exactly, banks had been exhorting their customers to view their home as an investment, only to be surprised when that was what the customers started doing.
My assumption is that they are perfectly capable of making their monthly payments but they choose to default on their mortgage rather than continue to throw good money after bad.
I tried for a loan modification and they denied it,this is when I had good credit score and never been late on my payment.
So, I stopped paying.
After 4 motnhs thebank has chaged their mind and is re-submittign the loan modification and it shoudl be approved this time. (Currently in progress)
Its true. The people who pay their mortgage and maintain responsibility get screwed.
Stop payig and be rewarded.
I wholeheartedly agree. Any bank stupid enough to issue a 95%+ LTV non-recourse mortgage deserves exactly what they get.
@shepd:
Or you do what banks traditionally did and require a hefty down payment specifically to avoid situations like this. Non-recourse mortgages on commercial properties are typically done at much lower LTV percentages than standard mortgages.
So, people with higher credit make better financial decisions? Makes sense. Has anyone done a study examining credit score vs. IQ - I'd be interested to see how strongly they are correlated.
Sad but true. I had an 815 credit score when I bought an investment condo in 1995 for $139,000, with a $119,000 mortgage. Could not flip it immediately. So, being responsible, tried to rent it. Throughout those years, the various renters I had:
Trashed it, did not pay rent on time, did not pay rent at all, abandoned the condo without telling me.
It got to be one giant headache. Even with tenants, I was bleeding $400 per month, let alone repairs. So, after thinking about it... I just listed it for short sale and stopped paying the mortgage. Mind you, all my other finances are in order. So, I "traded" saving $1000 a month for a crappy credit score.
It finally closed this week after 11 months on the market. My lucky buyer got this condo for $21,000 cash. I got a credit score that now sucks, but I have saved $11,000 (after already losing about $25,000 on the deal).
Just a business decision, no more, no less.
@GearheadGeek: I disagree. I don't think saying that group A is 50% more likely to do something a certain way means than group B implies that it is how group A usually does it. 'More likely' doesn't mean or imply 'often'.
@Deezul_AwT: I think I'm missing part of the picture here--are you having trouble making payments, or would you be needing to move even if you weren't underwater? It seems an awfully big hit to take to one's credit for a situation that you could just wait out unless one or both of those situations apply.
@Powerlurker: I'm not convinced of that, at least not in the majority of cases. It's not bad money if you can still afford it and don't need to sell, after all. However, I'm willing to concede I may be on the innocent side here.
This is why we can't have nice things.