April 14, 2012
Written by Lily Leung
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Wikimedia Commons | Credit: respres
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This bank-owned house on Oakpoint Avenue in Chula Vista was repossessed in 2011. Photo was taken in early February.
— Scott Allison / U-T San Diego staff
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Peter Safronoff could afford
his mortgage payments on his Rancho Bernardo condo, but the cost of
keeping it was pushing him into the red each month and eating into his
retirement savings. So like an increasing number of borrowers in San Diego County and elsewhere, the 64-year-old financial adviser chose to
walk away from his home.
What
Safronoff did, widely known as a strategic default, has not only become
less of a social stigma, it’s also considered a wise business decision
among a growing number of consumers, especially those who are severely
underwater on their homes.
An
estimated 35 percent of the U.S. home-loan defaults in late 2010 were
considered strategic, increasing from 26 percent in March 2009, based on
figures from the University of Chicago’s business school. This year,
the nation could see an increase in the volume of these defaults when
compared to last year, according to 46 percent of bank-risk experts surveyed by FICO analysts in February.
Now
that the country is about five years into one of the worst economic
periods in its history, it’s become more clear what factors motivate the
financially able to stop making their mortgage payments. Homeowners say
they are unable to modify their home loans with difficult lenders, need
to move but can’t sell their homes, and can’t keep justifying paying
for a home that’s already lost so much equity.
Narrowing
down why borrowers walk away is important because it could guide banks
and lawmakers on how to address a problem that continues to bleed out.
The body of studies on strategic defaulters is far from comprehensive
but keeps growing. Academics and businesses have found numerous factors
that push people to walk away from their mortgages.
The findings indicated that strategic defaults weren’t just about financial factors, “but also ideological and emotional ones.”
Financial reasons
Peter
Safronoff was able to pay his mortgage payments on his Rancho Bernardo
condo, but the cost of doing so was high. After doing the math, the
realized he was losing more than $1,000 each month due to a drop in
income and a special tax assessment on his home.
In
late 2008, he began to work with his lender to lower his mortgage rate.
After a yearlong process of dealing with more than 70 different
workers, Safronoff gave up. He stopped making
his payments, continued to live in his home and eventually was
foreclosed upon.
“I didn’t
feel guilt,” said Safronoff, whose credit took a brutal hit because of
the foreclosure. “I had to take care of myself.”
“The
idea of walking away was scary,” he continued. “I was taught not to do
that ... what swung me was, on a financial basis, I had to.”
The majority of clients share common characteristics: They bought at the height of the real estate market and are now severely underwater, or they need to relocate
but are saddled with a home that won’t sell, said company CEO and
co-founder Jon Maddux.
“I think people intend on
paying their mortgages and intend to follow through with the mortgage,
but things don’t always work out as planned,” said Maddux, whose company
has worked with about 8,000 defaulters nationwide.
Almost
23 percent of U.S. homes with a mortgage were underwater at the end of
2011, based on numbers from real estate data company CoreLogic. That’s
about 11.1 million properties. In San Diego County, that share is about one in three homes with a mortgage, DataQuick research show.
How
much a homeowner is underwater on their mortgage appears to influence
the likelihood of defaulting strategically, based on a June 2011 study
co-written by Paola Sapienza, a finance professor at Northwestern
University’s school of business management.
Of
the homeowners surveyed, 23 percent said they would walk away from
their mortgage if the mortgage exceeded the home’s value by $100,000,
even if they were able to afford the payments. That’s up from 8.9
percent, in a situation where the shortfall was only $50,000.
A similar result occurred when survey takers were asked about the relative value of the shortfall.
“The
willingness is clearly increasing over the relative value of the short
fall, with only 7.4 percent of the people willing to default when the
shortfall is 10 percent of the value of the house and 12.4 percent when
the value is between 40 percent and 50 percent.”
Social and emotional reasons
When
Peter Safronoff walked away from his Rancho Bernardo condo about two
years ago, his family was disappointed in his decision.
“They
were discouraged,” said Safronoff, who recently moved to Boca Raton,
Fla. “Ultimately, they understood what happened. They weren’t happy
campers, but they understand it now.”
The
stigma against strategic defaulters has softened in recent years, as
more borrowers have successfully walked away from their homes and even
lived in properties mortgage-free. So sets in the “social contagion”
effect, according to the paper co-authored by Paola Sapienza, of
Northwestern University’s school of business management.
“We
know in non-recourse states, banks are not going after borrowers,” said
Sapienza, who also is on the board of directors of the American Finance
Association. “… If their neighbor has done it, and they’re still in
touch with the neighbor, then, you’ll learn that nothing happened.”
Anger, specifically toward banks, is another key motivator.
Safronoff wanted to cooperate with his lender through a loan modification, but a year of back-and-forth eventually wore him out.
“They didn’t seem to operate on good faith,” he said. “I thought, ‘This is the way I’m going to be treated?’”
Public
anger is even quantified by one indicator co-released by the University
of Chicago and Northwestern University. More than 60 percent of people
surveyed said they were angry or very angry about the economy, according
to the latest results released in January from the Financial Trust Index, a quarterly look at how Americans feel about financial institutions.
“This
is the highest level of anger we’ve measured since March 2009,”
according to Sapienza, who co-authors the index. “In an election year,
this certainly indicates the importance of the economy to the political
agenda.”
Borrowers’ feelings toward
lenders also emerges as a theme in the 2011 study co-written by
Sapienza. In that paper, 44 percent of those surveyed felt less moral
obligation to pay their mortgage if they knew their bank was involved in
predatory lending, and it was 28 percent if they realized the bank had
received financial support from the government.
The results indicated that strategic defaults weren’t just about financial factors, “but also ideological and emotional ones.”
The consequences
Reasons
aside, lenders must deal with the high possibility that borrowers will
continue to consider strategic defaults. It’s unclear how they’ll
address the issue, especially considering the unprecedented negative
equity that’s suffocating U.S. homeowners.
Paola
Sapienza, of Northwestern University’s school of business management,
said it’s possible that if strategic defaults become rampant, then banks
could consider tightening their borrowing standards more than ever.
“We may move to a more European system, where credit is harder to get, and that will harm those who are truthful,” she said.
Analysts at FICO believe future strategic defaults could affect future borrowers.
“Regardless
of legal or ethical issues around strategic defaults,” said the
first-quarter FICO’s survey of professional risk managers in a report
released Wednesday, “Lenders must account for this risk when they
evaluate mortgage applications in declining markets.”
