A Chicago Tribune article entitled “The Cost of Walking Away from a House” explains that while owning more on your mortgage than the actual value of the property is a bad investment, choosing to purposely default on your mortgage, while having sufficient funds to pay it, is an even riskier decision.  A strategic default occurs when a home owner decides to stop paying his or her mortgage even though he or she is capable of repaying the debt.  This practice has become increasingly popular and commonplace; however, it poses a significant threat to consumer credit scores and the ability to secure credit in the future. 

There are several characteristics of a strategic default that requires consumers to think long and hard before choosing to simply walk away from an investment.  First, a strategic default is final.  It will lead to foreclosure, and foreclosure will lead to a negative effect on the consumer’s credit score. Further, the strategic default will be present on the credit score for seven years making it more difficult and maybe even impossible to secure credit at reasonable terms and rates during that time period.  In addition, in this day and age, lenders are not the sole inquirers into consumer credit score. Employers, insurers, cell phone companies, car dealerships, and many other entities that we require the services of on a daily basis are now looking into consumer’s credit scores and reports before choosing to form business relationships and extending services.

A great example of these affects  is the June 23rd announcement by the government controlled mortgage lender, Fannie Mae, that policy changes would be implemented in October of 2010  making consumers ineligible for a new Fannie Mae backed mortgage if they choose to strategically default on their investments.  The ineligibility will be locked in for seven years beginning on the foreclosure date.  An article entitled “Fannie Mae Gets Tough on Strategic Defaulters” tells us that Fannie Mae will go even further and take matters to court in an attempt to recoup outstanding mortgage debt from borrowers who decide to do a strategic default.  In addition, there is a bill awaiting Senate approval that would bar the Federal Housing Administration from insuring mortgages for consumers who took part in a strategic default. 

Fannie Mae does its own investigation to determine if a borrower is in default, and amongst the criteria they will look at is whether or not the homeowner still has access to credit and is paying that debt and others.  There is some controversy and disagreement amongst analysts and strategists as to whether or not this action of cracking down on strategic defaulters is effective or not.  Some say this needs to be treated as bad behavior in society and therefore should be punished accordingly, while others consider the harsh reaction to be, in essence, an overreaction, reasoning that this process already does enough damage to the consumer’s credit scores, and some leniency should be expected. 

A survey by Trulia and RealtyTrac found that two out of five homeowners would consider taking part in a strategic default.  Further, in the first half of 2009, there were 355,000 borrowers who strategically defaulted on their investments.

Finally, as if we needed more convincing on the risks of a strategic default, we learn that in some cases the debt that we think is being erased by the foreclosure may be recorded as income, which means taxes will have to be paid on it.  In essence, a strategic default may initially appear to erase consumer debt payment obligations; however, in reality, it does nothing more than transfer the payment and obligation of those funds to other areas, either in the form of monetary penalties or personal consequences, which can end up costing more in the end than just bearing the upside down mortgage initially. 

John Budz, Realty Executives, USA

source: Property Journal  8-9/2010