Some Homeowners Choose to Default on Mortgage

January 25, 2011 Updated: October 1, 2015

A house under foreclosure that is now bank owned in the Spring Valley area in Las Vegas on October 15, 2010. With the economic meltdown in high gear for a few years and foreclosures of homes continuing to hit the airwaves, a new phenomenon however, called strategic default has become prominent among homeowners.(Mark Ralston/Getty Images)
A house under foreclosure that is now bank owned in the Spring Valley area in Las Vegas on October 15, 2010. With the economic meltdown in high gear for a few years and foreclosures of homes continuing to hit the airwaves, a new phenomenon however, called strategic default has become prominent among homeowners.(Mark Ralston/Getty Images)
With the economic meltdown in high gear for a few years and foreclosures of homes continuing to hit the airwaves, a phenomenon called strategic default has become prominent among homeowners.

Strategic default happens when homeowners with mortgages far higher than the latest value of their property walk away from paying their mortgage, although they have the financial wherewithal to keep paying.

“A property owner normally considers a strategic default when the value of the property is below the mortgage balance due a lender,” according to The Strategic Default Monitor website.

Strategic default is addressed at the state, but not federal level. Therefore, those who use this method to walk away from paying a loan should consider the ramifications of such action in their state.

Defaulting on a loan is preferable to bankruptcy, since the latter makes it almost impossible to qualify for credit, as it will prominently appear on any credit report.

A strategic defaulter no longer makes mortgage payments for a number of reasons. “The rationale is that it does not make economic sense to make mortgage loan payments on a property that has no equity or any hope of gaining equity,” The Strategic Default Monitor explains.

Walking Away From Default

Real estate loans “failed, not because of morally bankrupt borrowers who go back on their ‘promises,’ but because bankers decided to count on a perpetually rising real estate market to absolve them of the necessity of responsible lending,” according to a 2009 article on the Big Money website.

Housing market experts suggest that the mortgage default phenomenon should be laid squarely at the doorstep of banks. Lenders, as well as builders and real estate firms, were instrumental in bidding up prices for real estate without concern for problems that might arise later on. Lenders, using shoddy underwriting practices, worked on the side of greediness instead of conservatism and caution, according to housing market experts.

To level the playing field and give the borrower a leg up, a number of states enacted laws that prohibit banks from making the borrower liable for the difference on a loan and the sale proceeds of a foreclosed home or any other type of product.
“A creditor cannot hold the borrower personally liable for more than the value of the property at the time of sale,” according to The Strategic Default Monitor.

States that have enacted such laws are called non-recourse or anti-deficiency states. States with non-recourse or anti-deficiency laws include Alaska, Arizona, California, Connecticut, Iowa, North Carolina, North Dakota, Minnesota, Montana, Oregon, and Washington.

“Generally, in a non-recourse state, if a lender cannot recoup its loan from the sale or seizure of the asset used for collateral, then the relevant state law will limit the lender’s ability to collect from the borrower,” according to The Strategic Default Monitor.

Besides a non-recourse state, there are also one-action states, where the lender has only one choice: foreclose or take the defaulter to court. States that have such a law on the books are California, Idaho, Montana, Nevada, New York, and Utah.

In states that do not have the non-recourse or one-action law, the state established strict requirements for collecting from the defaulter on any type of loan. If a lender just misses a single requirement under the law, it might not be able to win any court proceeding. States with recourse laws include Colorado, Virginia, Michigan, and Ohio.

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