Business & Finance Finance

Strategic Default: Banks Do It, Now Consumers Are Following

A strategic default specifically refers to when a homeowner stops making payments on a home not because they cannot afford to make the payments, but because they believe continuing to pay on their mortgage is not in their financial best interests. Most strategic defaults occur when an individual's home drops significantly in value. Because of the recent housing market collapse, many homeowners now owe more money on their property than their property is actually worth. A property that has a higher mortgage than its value is often called an underwater property. Even if homeowners keep paying the bank back, it is unlike that they will ever recoup their losses. They will be spending hundreds of thousands of dollars on a property that they will never be able to sell for even a fraction of what the homeowners originally paid for it. For these homeowners, it makes more sense to stop paying the bank than it does to keep throwing money down a black hole.

The practicality of a strategic default varies widely from state to state. In some states, the bank can pursue the homeowner for the full amount of the debt, even if the homeowner gives the house back to the bank. In other states, once the homeowner has given their property back to the lien-holding bank, the bank cannot pursue the debt any further. The homeowner is allowed to simply walk away. Homeowners, who are increasingly disillusioned with the banking industry, say that banks feel no obligation to uphold their end of the bargain. Banks frequently sell mortgage debt to others, showing no loyalty to the homeowner who entered the mortgage agreement with the bank.

Homeowners who are planning on defaulting on their mortgage should be prepared to live without credit for a few years. Defaulting on a mortgage severely damages a consumer's credit rating, but this does not mean they will not be able to live in modern society. Experts in strategic mortgage defaults state that consumers should prepare for a three to five year period where they will not be able to get financing for anything. Consumers should purchase a new car if they need one before they stop making mortgage payments. Renting an apartment is usually not a problem, although some rental companies do check the credit score of anyone who applies to live in their apartments. Consumers should also be prepared to pay a higher deposit on any apartment that they rent. Some homeowners whose property has gone underwater, so to speak, are so disillusioned with the real estate system that they have no intention of ever buying a home again.

Financial experts who study this phenomenon believe that more individuals would default on their mortgage if not being able to pay debts was not so stigmatized by society. As the actions of the financial sector are increasingly being seen as morally dubious, this might cause more homeowners to feel less guilty about defaulting on their mortgages. It remains to be seen how widespread strategic defaults become.

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