Strategic foreclosures: defaulting when you can pay

June 30, 3:13 PMBoston Economic Policy ExaminerAleksandra Balyanova

Previous Next

2 comments Print Email RSS Subscribe

Subscribe

Get alerts when there is a new article from the Boston Economic Policy Examiner. Read Examiner.com's terms of use.

Email Address   Include other special offers from Examiner.com Terms of Use

Photo: Mike Licht

A new study, detailed in this blog on the Wall Street Journal, finds that one out of four defaults on mortgages is “strategic” - meaning that the mortgage-holder does not pay and goes into foreclosure even when he could have afforded his mortgage payments. This occurs when the negative equity in the home passes a certain threshold. In simple terms, if the homeowner is paying a mortgage based on an older, higher assessment of the value of his home, but that same home is now worth significantly less, he may walk away and let the bank have it - even if he could have afforded his mortgage. This finding may seem obvious to some, but its implications for how we view homeownership are not. We have always thought that in addition to serving as shelter, a house is purchased as a long-term, low-risk investment. It seems, however, perhaps due to the housing crisis, people are not so inclined to “wait it out”, and are pulling their money as soon as negative equity reaches 10%.

Another finding of the same study emphasizes the importance of your neighbors in your decision to foreclose - because of social stigmas, foreclosing is easier when many in your neighborhood have done the same. Aside from social stigmas, watching a neighbor default on his mortgage makes one more pessimistic about the property values in the neighborhood and therefore the value of his own home. The more people foreclose in a neighborhood, the more the social stigmas are loosened, and the lower the property values in that neighborhood become. These effects lead to a “bubble” in a given neighborhood, with several foreclosures leading to many more.

These two findings together show that the difficulty of affording a mortgage is only a fraction of the story and that a foreclosure is often no more shameful than withdrawing one’s money from a bad investment. In addition, foreclosures are much more a regional problem than an individual one - each zip code is at risk of experiencing its own mini housing bubble.