The collapse of the housing market has pushed more than 11 million homeowners into the uncomfortable position of owing more to their lender than their house is worth. A third of the mortgages held in California fall into this category, according to housing market analyst CoreLogic. Many of these borrowers are voluntarily defaulting on loans even though they could still afford their payments, calculating that their homes will never regain their value.
During debate last week on a bill (HR 5072) to shore up the Federal Housing Administration's mortgage insurance program, the House decided to crack down on such "strategic defaults." Lawmakers agreed to a proposal by Rep. Christopher Lee (R-N.Y.) to make those who strategically default ineligible for new FHA-insured loans. The ban sends the right message, but it's not likely to make much of a difference to the borrowers mailing in their keys.
Surveys suggest that strategic defaults are rising fast, especially in California and other states where property values have tumbled sharply. One report last year estimated that there would be more than a million such defaults in 2009. And Moody's Economy.com estimated that this category accounts for almost one-tenth of defaults by homeowners whose mortgage debt is at least 20% higher than their property values.
Part of the outrage about strategic defaults stems from anecdotal evidence of borrowers gaming the system, spending lavishly on themselves instead of paying their mortgage. Yet such excesses don't explain why borrowers are choosing to default. For many, it's a rational response to owning a house that may never be worth what they are investing in it. If they live in states that bar banks from recouping more from foreclosed borrowers than the value of their homes, defaulting may simply be a way to stop throwing good money after bad. The penalty these borrowers face is a precipitous drop in their credit ratings, making all forms of credit scarce and costlier. That's far more serious than the potential loss of access to FHA-insured loans, which ordinarily account for just a fraction of available mortgages. Yet strategic defaults continue to climb.
It's lenders, not lawmakers, who are best able to slow the pace of strategic defaults, because they're the only ones who can narrow the gap between the diminished value of a house and the amount of its mortgage. Given how hard it is for banks to justify writing down debt when the borrower can afford the loan, the rise in strategic defaults may be unstoppable. Call it another price paid for the country's housing folly.