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Strategic Mortgage Defaults… For or against?

There has been quite a bit of controversy lately on the topic of strategic mortgage defaults. If this phrase is unfamiliar to you, it can be summed up like this:

A strategic mortgage default is when you have sufficient funds to continue making mortgage payments on your residence, but choose NOT to make them because your home value is less than your mortgage balance.

It is happening all over the country by homeowners like yourself. Large corporations have done it too! What is ironic about this, is that while the banks frown upon homeowners who default on their mortgage, the Mortgage Bankers Association (MBA) strategically defaulted on a building they owned!

In a study by Brent White at the University of Arizona (where the housing market has been hit worse than other areas), he posited that strategically defaulting on a mortgage is not immoral, nor is it necessarily wrong. In fact, he believes that it should be based purely on sound financial logic, something that large corporations have done for years. Think of it this way: Why should you continue paying money towards a home that has little or no chance of regaining value in the foreseeable future? Wouldn’t it make more sense financially to just rent instead?

I’m not sure where I stand on this topic. As someone who was raised to be a good citizen, taught to obey the rules, pay my bills, etc, my conscience tells me that it is wrong! However, the left side of my brain tells me that it makes absolute financial sense in certain situations. Additionally, as someone who makes a living selling real estate, how can I support such an idea when my financial livelihood relies upon a strong housing market?

I read a story a few years ago where homes in a particular neighborhood saw their values drop by 50% or more. The story chronicled one particular homeowner who purchased a home a few doors down that was identical to his for half the price he paid. He then defaulted on his original home. The bottom line was that he reduced his mortgage by half for the same home! He said in the interview that he tried to work with his bank to reduce his mortgage payment, but they wouldn’t even talk to him unless he was in arrears by several months.

Fast forward to 2011 in Lynnwood WA. There is a condo complex that I’ve been showing to potential investors. There are 19 units for sale in this complex (out of nearly 200 units). ALL are either Short Sales or Bank Owned (REO), and all are selling for about 50-70% of their original sale prices. I also happen to have a friend who owns a unit here. I explained the concept of Strategic Defaults to her and she mentioned that she would feel too guilty to try it. The Seattle Times recapped Mr. White’s article just this weekend. Here is a link to it.

And that, is what the book that Mr. White wrote, focused on. He wrote that we shouldn’t feel guilty about defaulting if the numbers don’t pencil out. Do you think that the Mortgage Bankers Association felt guilty when they defaulted on their building loan? How about Morgan Stanley when they defaulted on a $2 Billion loan in 2009?

His position on the subject is that a loan is just a business contract. You pay your mortgage off, and you get to keep the house. If you don’t the bank gets to take it back.  If you’re willing to give the house back to the bank, why should you feel guilty? You’ve lived up to the agreement stated in the contract, didn’t you?

What are your thoughts on the matter? I’ve got additional thoughts that I’ll save for tomorrow…

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