Strategic Defaults Expected To Rise In 2010

Another stumbling block for the housing market this year may be homeowners who are able to pay their mortgages but choose not to because their home is so far underwater. With over 5 million mortgage holders projected to be significantly underwater by June, strategic defaults will be on the rise. See the following post from Expected Returns.

From the New York Times, No Relief in Sight, More Homeowners Walk Away:

New research suggests that when a home’s value falls below 75 percent of the amount owed on the mortgage, the owner starts to think hard about walking away, even if he or she has the money to keep paying.

In a situation without precedent in the modern era, millions of Americans are in this bleak position. Whether, or how, to help them is one of the biggest questions the Obama administration confronts as it seeks a housing policy that would contribute to the economic recovery.

The number of Americans who owed more than their homes were worth was virtually nil when the real estate collapse began in mid-2006, but by the third quarter of 2009, an estimated 4.5 million homeowners had reached the critical threshold, with their home’s value dropping below 75 percent of the mortgage balance.

They are stretched, aggrieved and restless. With figures released last week showing that the real estate market was stalling again, their numbers are now projected to climb to a peak of 5.1 million by June — about 10 percent of all Americans with mortgages

Introducing the strategic default- yet another factor that will weigh down on housing. The only thing that can prevent a trickle of foreclosures turning into a flood is an immediate V-shaped rally in home prices, since time is the enemy of underwater homeowners, especially with rising carrying costs. However, even if consumers are willing to step in and buy homes, banks are still wary of extending credit.

The estimated 5.1 million homeowners with home values below 75% of mortgage values, or 1 in 8 homeowners, will eventually capitulate. With over 15 million Americans (and rising) currently unemployed how will housing recover? Watch for mortgage resets in upcoming months to provide the knockout punch for many homeowners and effectively negate the influence of tax-credits on home prices.

"We’re now at the point of maximum vulnerability,” said Sam Khater, a senior economist with First American CoreLogic, the firm that conducted the recent research. “People’s emotional attachment to their property is melting into the air.”

The difference between letting your house go to foreclosure because you are out of money and purposefully defaulting on a mortgage to save money can be murky. But a growing body of research indicates that significant numbers of borrowers are declining to live under what some waggishly call “house arrest.”

Using credit bureau data, consultants at Oliver Wyman calculated how many borrowers went straight from being current on their mortgage to default, rather than making spotty payments. They also weeded out owners having trouble paying other bills. Their estimate was that about 17 percent of owners defaulting in 2008, or 588,000 people, chose that option as a strategic calculation.

Evidence continues to mount that national home prices will fall in 2010. Too many people are jumping directly into the fire and buying homes, not realizing the tenuous state many homeowners are in, while ignoring tremendous overhang of shadow inventory- which will put a lid on any housing recovery.

This article has been republished from Moses Kim's blog, Expected Returns.