Strategic Defaults Hurt Other Homeowners

Everyone knows that falling home prices and high unemployment are bad news for the housing market and economy. Economists worry that people who can’t afford their mortgage payments will default, leading to foreclosures, a glut of homes from sale, driving prices down further. You get the picture — a vicious cycle.

Well, now add something else to this gloomy scenario — strategic defaults. This refers to people who can afford their mortgage payments but simply choose not to make them. The most likely reason is they see no reason to continue payments on a home that is worth less than they owe.

Experts have been worrying about this for some time, but now economists at Moody’s Economy.com warn that strategic defaults could "derail housing recovery."

"Such so-called strategic defaults, once rare, are now common enough to jeopardize the already-weak housing and mortgage markets," wrote Celia Chen and Cristian deRitis. "If the trend continues, strategic defaults could both accelerate the pace of home foreclosures and also make it harder for new borrowers to obtain mortgages. Both factors would in turn worsen the decline in house prices."

Citing a variety of studies, Chen and deRitis estimate that 20%-25% of recent mortgage defaults are strategic.

"Borrowers watching their largest asset rapidly sink in value may easily conclude that they were misled by lenders and are thus justified in walking away," they write.

According to Economy.com, about 15.5 million homeowners are underwater, owing more than their homes are worth, up from less than 3 million in 2006. That means one in five homes is underwater. About 9 million borrowers owe at least 25% more than their homes are worth.

Certain parts of the country, generally those that had the biggest home-price bubbles a few years ago, are even worse off. More than 60% of homeowners in Nevada are underwater, for example.

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