Posted September 6th, 2011 under Definitions

What is Strategic Default?

Tags: Strategic Default, Short Sale Realtors, Short Sale Specialists, Phoenix Short Sale Realtors, Seattle Short Sale Realtors

A strategic default is a decision by a homeowner to stop making payments on their mortgage (to default) even though they are financially able to continue to do so.  Why would someone do this?  Usually it occurs when the market value of the property drops substantially below the amount owed.  The property becomes “underwater” and continuing to make payments on this property is like throwing money out the window!

 

Last May, a very significant analysis of strategic defaults was published by the Federal Reserve Board. Entitled “The Depth of Negative Equity and Mortgage Default Decisions,” it was extremely focused in scope. The authors examined 133,000 non-prime first lien purchase mortgages originated in 2006 for single-family properties in the four bubble states where prices collapsed the most -- California, Florida, Nevada, and Arizona. All of the mortgages provided 100% financing with no down payment.

By September 2009, an astounding 80% of all these homeowners had defaulted. Half of these defaults occurred less than 18 months from the origination date. During that time, prices had dropped by roughly 20%. 

 

Clearly, homeowners with no skin in the game have little incentive to continue paying the loan when the property goes further and further underwater. Even those that placed a significant down payment on their home upon purchase may find themselves upside down in today's market with little financial motivation to continue making payments given their negative equity position.