Strategic Default And The Morality Of Walking Away

By Michael Schreiber

A few weeks ago I talked to a friend about his mortgage. Like many homeowners, he and his wife have seen the value of their house plummet since they bought it three years ago. Despite putting down 20 per cent, their house is now underwater, meaning they owe more than it’s worth. It’s a distinction they share with 27 per cent of American homeowners.

My friend – let’s call him Brad – doesn’t have many good choices. He and his wife – let’s call her Angelina – could hold on to the place and hope the market rebounds. But they need more space, so that’s not ideal. They could sell it at a loss, but they’d lose their entire down payment and still be out of pocket. That obviously doesn’t appeal. They could try to rent it out and rent something bigger, but the maths doesn’t quite work for that option, either.

I told Brad about a third option… called strategic default.

The tactic

A strategic default occurs when someone simply decides to stop paying their mortgage and property taxes, and chooses to let their house fall into foreclosure. The bank that holds the note on the house takes possession of the property and eventually sells it. It also gets to keep the down payment and everything that’s been paid on the mortgage up to that time. Meanwhile, the homeowner gets to live in the house without paying a dime until the foreclosure goes through and the bank takes possession.

[Related: Why the Home Loan Mod Program is Failing]

The average homeowner facing foreclosure hasn’t made a payment in 507 days, which means that by the time they are forced to vacate, they can live rent-free for as long as two years, and maybe longer, according to a recent report. Ideally, this affords them a chance to recoup a sizeable chunk of the money they put down on the house. And though the stain of foreclosure on their credit report will likely prevent them from buying a house for the better part of the next decade, they will have saved up enough to rent a pretty nice place in the interim. They also should be able to save lots of money toward the down payment on a future house.

Sounds like a no-brainer, right? Well, when Brad told Angelina about strategic default, she said it was simply not an option…and she barred Brad from talking to me about real estate ever again.

Angelina’s aversion to strategic default is hardly unique. A recent survey indicates that most Americans oppose the idea. We asked participants if they’d do a strategic default if their homes were underwater. We explained that it could mean living for up to two years rent-free, in return for a seven-year stain on their credit reports.

This national RDD Probability Sample telephone poll was conducted for by GfK Custom Research North America from January 14-16, 2011. A total of 1,004 interviews were completed, with roughly 531 female adults and 473 male adults. The margin of error is +/- 3 percentage points for the full sample.

The results couldn’t have been clearer. More than 83 per cent of respondents say they were either ‘not very’ or ‘not at all’ likely to do a strategic default.

The dilemma »

Photo: Linus Bohman, via; Graph:

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