Should You Strategically Default?

| February 12, 2010 | 0 Comments

Yesterday, RealtyTrac released their January 2010 Foreclosure Market Report.  The report provides a look at foreclosure activity for the month. I’m shocked by what I read.

A whopping 315,716 US properties had some sort of foreclosure filing in January.  That’s one in every 409 US households.  And it’s the 11th consecutive month 300,000 or more homes received a foreclosure filing.

Foreclosure activity is up 15% over January 2009.

Clearly the US housing market’s still suffering badly.  This is a bad sign for homeowners.

Record numbers of homeowners now owe more on their mortgage than what their home is worth.  It’s known as being “underwater”.

Homeowners who are underwater are faced with a tough choice.  They can continue to pay their mortgage and hope real estate prices recover, or they can choose to “strategically default”.

A strategic default is when a homeowner who’s underwater on their mortgage, but can still afford the payments, chooses to walk away and let the lender foreclose.

The hard reality for many homeowners is a strategic default may be their best choice.

Homeowners who bought near the peak of the market have very little chance of seeing their home values rise to breakeven levels.  That’s because the loose lending practices that fueled the boom are unlikely to ever return.

So from a purely financial standpoint, defaulting on your mortgage is the best option.  It’s just like cutting your loss on a stock that’s plummeted in value.  It’s better to take the loss and move on than it is to hold and hope.

The problem is most homeowners won’t walk away unless they have no other choice.  They feel a moral obligation to keep paying their mortgage even if it’s not in their own best interest.

And, lenders are taking advantage of this moral dilemma.  They’re preying on homeowners’ sense of morality to line their own pockets.  Lenders are stubbornly refusing to negotiate with homeowners.

They believe they’re serving their own interests by refusing to renegotiate the terms of existing loans.  And I’m sure some people will never stop making payments, even if the property value falls to zero.

But the RealtyTrac report tells me strategic defaults are becoming an acceptable means to deal with an underwater home.

Unfortunately, lenders don’t realize the rules of the game are changing. More and more people are going to walk away unless lenders work with homeowners to reduce the principle on their mortgage.

Sadly, I don’t think that day will ever come.  The hard reality for underwater homeowners is, the sooner you walk away, the better off you’ll be.

It’s the same principles as when you’re investing in any other asset class. Cut your losers short…

It’s time to get over the moral implications of cutting a loss on real estate and do what’s in your own best interest.

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Category: Real Estate

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Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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