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May 5th, 2010 (Modified on January 30th, 2013)

Strategic Defaults are Increasing, but So Are Home Improvements

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Back in early April we polled our readers and asked, “How do you feel about your home — do you view it as a burden or an investment, is it neither, or do you rent?”

How Do You Feel About Your Home?
-vote on our poll (below)-

An equal amount of our respondents said “It’s a burden, I want out,” and it’s “Not a burden or an investment, I need to live somewhere.” The poll was inspired from a recent Fannie Mae survey that found a majority of Americans want to remain in their homes and still view them as a worthwhile investment.

But what about the others — what about those who no longer see their homes an investment? According to another recent survey from the Chicago Booth/Kellogg School Financial Trust Index, more and more of “those” borrowers are deciding to walk away from their mortgages — even though they can still afford to make payments — because their homes are worth far less than what they still owe their lender:

The researchers found that the number of homeowners willing to default…dramatically increased compared to just a year ago. The percentage of foreclosures that were perceived to be strategic was 31 percent in March 2010, compared to 22 percent in March 2009.

What’s behind the increase? While the “social stigma” of walking away may be fading, so too may be the fear that lenders will go after borrowers who default on purpose:

As the number of borrowers who walk away from their mortgages increases, the social stigma associated with foreclosure has started to wane, experts say. “It can be a very logical decision based purely on economics, numbers and returns,” says Keith Gumbinger, of HSH Associates, a mortgage publishing website. “Is there better value to me to abandon this home and rent another one for less money?”

According to the Chicago Booth/Kellogg School Financial Trust Index:

One likely reason for this growing trend is the increasing perception that lenders are not pursuing borrowers who walk away. In December 2009, the average homeowners surveyed said the probability that a lender will pursue a borrower is 56 percent, as compared to 54 percent as reported in March 2010.

“With more and more homeowners believing that lenders are failing to pursue those who default on their mortgages, there is a risk that a growing number of homeowners will walk away from their homes even if they can afford monthly payments,” said [Paola Sapienza, professor of finance at the Kellogg School of Management].

How do we balance two competing facts: a majority of homeowners still feel that their home is a worthy investment (Fannie survey), while at the same time, strategic defaults are on the rise (Chicago survey)?

As the results from both the Fannie and the Booth/Kellogg surveys suggest, this opposing behavior (or mindset) is occurring simultaneously. According to the Leading Indicator of Remodeling Activity (LIRA) indicates that for the first time in years, spending on home improvements could increase in 2010. This would seem to bear out Fannie’s results to a greater degree.

“Yes, one of the consequences of the decline in housing prices is a slower turnover rate and greater difficulty for homeowners to swap one house for another, i.e., ‘move-up.’ This makes renovation, rather than a move, more attractive,” said Dennis Capozza, finance and real estate professor at the University of Michigan’s Ross School of Business (source: National Mortgage News, May 2010).

“However, this can occur at the same time that so-called strategic defaults are increasing because of the cumulative effect of price declines. Both are driven by the unusual market conditions we are experiencing and can occur together.”

Given that there’s a legitimate divide between those who feel that it’s worth staying in their current home (even if it’s underwater) and those who don’t, we’ll ask you again:

How Do You Feel About Your Home?

View Results

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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