Many of us probably know someone who has lost their home in this economic downturn, and therefore can empathize with whatever situation—whether they lost their job or were a victim of predatory lending—made it nearly impossible for them to stay current on their credit obligations (mortgage as well as credit cards, auto loans, etc.).
At the same time, there are a growing number of “strategic defaulters” or “walkaways” who, it could be argued, garner less sympathy. Approximately 35% of mortgage defaults were strategic defaulters in September 2010, according to the University of Chicago Booth School of Business—up from 26% in March 2009. These are people who stop making payments on their mortgage despite having the financial ability to make the payments. This is particularly associated with the situation where the loan amount is considerably higher than the value of the property. The property has negative equity or is “underwater”—and in many cases is expected to remain so for the foreseeable future.
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For example, the median home price in Merced, California, was $116,000 in the first quarter of 2011—down 68% from its peak in 2006, according to a recent USA Today article. Three of five homeowners with a mortgage in Merced owe more on their loans than their houses are worth, compared with about one in five nationally. Some of these people will likely make the “strategic” decision to walk away from the property even though they have the ability to make the payment. They are willing to accept how this decision will affect their credit score (up to a 150-point drop in a FICO score), which will make it difficult for them to get affordable credit in the near future.
Take heed, new analytics are being developed and tested that help lenders identify likely strategic defaulters before they hand over the keys to the house.
FICO has just announced the development of a new analytic solution lenders can use to identify mortgage loan holders who are most likely to walk away from the loan. If mortgage servicers adopt the solution, they can more accurately identify the potential strategic defaulter before he/she walks away, and intervene to educate them on the negative ramifications of walking away, as well as pointing them to alternative solutions to modify their loans.
FICO research found that the credit profile of the strategic defaulter differs from how general defaulters have managed their credit prior to defaulting. They tend to have:
- Higher FICO scores
- Lower utilization on their credit cards/less likely to be overlimit
- Less retail credit balances
- Shorter time living in the property (less established roots in community/less equity in home)
- Active opening of new credit in most recent 6 months
The growing trend of consumers walking away from their mortgage obligation has several negative impacts:
- For the strategic defaulter, it will negatively impact his/her credit score—increasing the cost of credit and potentially other living expenses (rent, insurance, etc.).
- If you reside in a recourse state, servicers that sell a foreclosed property for less than the amount owed on the mortgage can still pursue the defaulter for the difference.
- The ability to purchase a new home in the foreseeable future is affected. According to policy changes announced by Fannie Mae in July 2010, defaulting borrowers who walk away but had the capacity to pay or did not complete a modification alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for seven years from the date of foreclosure (borrowers who have extenuating circumstances may be eligible for new loan in a shorter timeframe).
- The decision to walk away from a mortgage loan also negatively impacts the local community by increasing vacancy rates, reducing the tax base and further stagnating economic recovery.
Strategic defaults have negative impacts for servicers, investors, borrowers and the community as a whole. Hopefully these new predictive analytics will help servicers identify potential strategic defaulters before it is too late to take alternative actions that can have a more positive outcome for everyone.
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