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Is Strategic Default Really the Best Strategy?

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By : Gary Lundholm    99 or more times read
The recent recession has caused considerable hardships for countless citizens of the US; job losses, the real estate crisis, reduced spending and over-extended credit have all contributed to the downfall of many households and businesses. While there is no denying the tragedy that has befallen on many of our neighbors, there is a disturbing trend developing across the nation.

The headlines are dominated by stories of financial ruin and heartbreak, leading us to believe the entire nation is crumbling into financial ruin, when in reality the majority of Americans have kept their jobs and, for the most part, maintained their lifestyles. There are record numbers of foreclosures all across the country and many of them are justifiable; however, there are also an alarming number of strategic defaults occurring (1 in 4 foreclosures), and that is cause for concern. A strategic default is when a homeowner walks away from their property despite having the financial ability to make the mortgage payments. The rapid decline in real estate values has convinced many homeowners that there is no point in paying on a mortgage that is way higher than the value of their home. Recent statistics peg the number of households in this situation at 4.5 million.

As with any issue of this magnitude, there are strong opinions on both sides of the argument. On one side, there are those that believe it is highly unethical to walk away from a mortgage contract when you're still financially able to make the payments. When a borrower enters into an agreement with a financial institution they have to convince the lender that they have the means to honor the terms of the contract. If the lender agrees, a legal contract is signed (this is usually followed by a congratulatory hand shake) and the borrower is now obligated to make the payments. Walking away from the home and dishonoring the contract is a breach of good faith between the lender and the borrower and should not be accepted as an option.

On the other side are the proponents of strategic defaults who suggest that a mortgage contract is nothing more than a business deal and, like many deals in the financial world, if the terms no longer benefit both parties, the deal is broken. The fact that it is just a business deal should exclude any moral, emotional, or ethical underpinnings. This group feels that there is a moral obligation to be responsible to family first, and if your family's situation is compromised, action must be taken. It is also thought that the banks deserve what they get, as they should be responsible for freely handing out mortgages to less than qualified borrowers; which, ultimately caused the housing bubble and the subsequent bursting of the bubble that saw housing values plummet. Those against strategic default argue that the banks should not be blamed for the bad decisions made by consumers.

Walking away from a home has many consequences that need to be considered before the keys are handed in. First of all your credit rating will take a big hit, up to 200 points in some cases. Secondly, it will be very difficult to obtain credit for a number of years, and if a lender does agree to issue another loan the interest rates will be quite high. There is also the negative social stigma associated with losing your home. How will friends and family look at you after you abandon the family home, even though you could afford to stay there. Most important of things to consider is that in some states (i.e. Florida and Nevada) the bank is able to pursue repayment of the defaulted amount either on their own or through a collection agency. Certain jurisdictions allow up to 20 years to recover the outstanding debt.

Does the value of a house make it any more a less a home? If you can still afford the mortgage payments is it worth the stress and grief to uproot your family and move in to a rental property simply because the home's value has decreased. On the other hand, if your house was purchased solely as an investment vehicle and you have no emotional ties to the property, then walking may be the best option for you; just be sure you have considered all of the repercussions that can result from the decision.
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