Sunday, July 10, 2011

'Strategic defaulters' tend to be affluent, savvy homeowners

Many of the people who have been walking away from mortgages over the past few years don't fit the standard profile.

Cash-strapped? Unemployed? Financially unsophisticated? Low-income?

None of those descriptions seem to apply to most "strategic defaulters" - homeowners who have chosen to cut their losses on properties that dropped in value, just as they might sell an old car with mounting repair bills or dump stock in a company that just reported a loss.

"Many are financially savvy people with higher credit scores and higher income," said Tracy Bremmer, director of decision analytics at credit-bureau Experian, which has studied the issue to help lenders identify people who might be default candidates. "They often own multiple properties, with larger original loan amounts."

Strategic defaulters, in other words, seem to know what they're doing. In fact, they're often angling to buy the foreclosed home across the street at a bargain price before abandoning their own property, Bremmer said.

"They'll open a new mortgage before defaulting on the existing loan," she said.

Experian cites data, gleaned from consumer-credit reports, that point to the upscale nature of strategic defaulters.

- Of defaulting homeowners with original loan balances below $50,000, only 6 percent were strategic defaulters. Yet they constituted one-third of defaulters on loans with balances above $1 million.

- Only 9 percent of defaulters earning less than $40,000 a year were strategic defaulters, compared with 30 percent of those making more than $150,000.

- In the six months prior to defaulting, nearly half of the people who became strategic defaulters obtained a new mortgage.

Strategic defaults have helped to prolong the real-estate slump. If there's a silver lining, it's that the worst of this trend might be over.

At the end of 2008, a record 20 percent of the homeowners who were 60 days or more delinquent were strategic defaulters, Experian reports. That has eased to 17 percent.

Defaulting on a loan - that is, missing payments - will hurt your credit score. But many strategic defaulters apparently don't worry about this or consider it a lesser evil.

"They probably already have their credit relationships in place, with cash in the bank," Bremmer said.

Still, strategic defaulters tend to keep current on other obligations such as credit cards and auto loans. In fact, this tendency to keep making other payments is how Experian sorts out strategic defaulters from more distressed borrowers.

"They're skipping out on their mortgages but paying everything else," she said.

How big is the credit-score damage from a default? It depends on several factors, including a person's initial score and the scoring system used.

Someone with a high starting score of 780 on the FICO scale (which ranges from 300 to 850) could lose roughly 100 points if falling 30 days or more late on a mortgage payment. The score might drop further, into the 620-640 range, if things proceed to the point where the property is given up in a short sale and the lender isn't fully repaid, or in the case of a foreclosure.

On the VantageScore system, where scores range from 501 to 990, a defaulter with otherwise good credit might suffer a drop of 100 to 140 points from a mortgage default, plus a 50-point ding when the property slips into foreclosure, Bremmer said.

The score-repair time also varies, depending on the severity of the problem and later borrower behavior. Those with a mediocre initial credit score who miss a mortgage payment could recover in perhaps three months, reports FICO, while those hit with a foreclosure might need three years. By contrast, for borrowers with initially strong credit, recovery would take roughly three to seven years.

By walking away from mortgages, strategic defaulters have raised difficult ethical questions.

Is it prudent to stop paying on a bad loan and treat it like any other business decision, especially if you would be sticking it to a bank that might be guilty of its own misdeeds?

Or should you continue making payments if you can afford them, especially since walking away would hurt your former neighbors, homeowner association and community?

In a survey by the Pew Research Center last year, 59 percent of nearly 3,000 respondents found strategic defaults unacceptable. But 36 percent said they could be justified, in at least some cases.

While Experian's data indicate the proportion of strategic defaults has peaked, it will be a while before they're no longer hurting the real-estate market.

"Until we see home prices improve, I don't think we'll see this going away," Bremmer said.

by Russ Wiles The Arizona Republic Jul. 10, 2011 12:00 AM

'Strategic defaulters' tend to be affluent, savvy homeowners

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