There are some ways to tackle a mortgage if you find yourself unable to afford the payments, like loan modification and refinance, but they don’t always help. There is one other alternative that can save you from paying thousands of dollars in mortgage payments – strategic default.
Strategic default is intentional non-payment on a mortgage when the borrower’s property goes ‘underwater’. The negative equity in the property is a result of a significant decline in the property’s price, a problem that has affected many people since the real estate bubble burst. The market value of the home would now stand far lower than the mortgage due on it. Borrowers who choose to deliberately default on their mortgage payments are called ‘walkaways’.
The trend of strategic defaults is seen as a consequence of the sub prime mortgage crisis. So far, nearly a fifth of underwater mortgages have led to homeowners defaulting on payments.
Support for strategic default
Strategic default is at the centre of a heated ethical debate. People in favor of it argue that the short term costs of walking away from a mortgage, including a negative hit to one’s credit score, are outweighed by the long-term financial benefit that the borrower gets from such a move. Borrowers should expect to take an initial hit of 100-150 points on their credit score. Along with the late payment and foreclosure, they can be looking at a total of 300-400 points.
However, strategic defaulters can get an improved credit rating over a period of 2-3 years after foreclosure by paying off other creditors. The only thing stopping the borrowers is that the government, the financial industry and the media have created a moral barrier that forces people to pay their mortgage.
Criticism
Critics of strategic default point out that such a default would have a serious negative impact on a borrower’s credit score, and make it more difficult to obtain future credit. They claim that dealing with the credit score hit will not be easy, and if the borrower needs another loan in the near future, he would have to pay a much higher interest. This will offset any financial benefit that the borrower would have got from the default.
Apart from the damage it can do to a borrower’s credit history, approving strategic defaulting as a sound financial decision would also stop people who can afford the payments from meeting their debt obligations. This would have a huge negative impact on the overall housing market.