Strategic Default Is Rising, Researchers Say

The number of homeowners willing to default when the value of a mortgage exceeds the value of their house, even if they can afford to pay their mortgage, dramatically increased compared to just a year ago, a pair of Chicago researchers say.

According to the Chicago Booth/Kellogg School Financial Trust Index, a quarterly look at Americans' trust in the nation's financial system, the percentage of foreclosures that were ‘perceived to be strategic’ was 31% in March 2010, compared to 22% in March 2009.

One possible explanation for this growing trend is that borrowers believe lenders are not likely to go after borrowers for deficiencies. In December 2009, homeowners surveyed said, on average, the probability that a lender will go after a borrower is 56%, as compared to 54% reported in March 2010.

"With more and more homeowners believing that lenders are failing to pursue those who default on their mortgages, there is a risk that a growing number of homeowners will walk away from their homes even if they can afford monthly payments," says Paola Sapienza, a professor of finance at the Kellogg School of Management at Northwest University. She co-authored the report with Luigi Zingales, a professor of entrepreneurship and finance at the University of Chicago Booth School of Business.

Research also indicates that the likelihood of strategic default increases by 23% when homeowners learn that their neighbor with negative equity has received a partial loan for forgiveness. Additionally, strategic default increases by 29% if homeowners are able to find an alternate way to finance a new home.

Sapienza and Zingales were able to pinpoint a deterrent to strategic default: borrower fear of losing a good credit score.

"Approximately 74 percent of homeowners in our survey believe it is very important to maintain good credit, and this can be a factor in encouraging them not to walk away," says Zingales.

These findings build upon a paper the researchers released in June 2009 titled "Moral and Social Restraints to Strategic Default on Mortgages," which looked at American homeowners' propensity to strategically default.

SOURCE: Financial Trust Index


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