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More Homeowners Walk Away From Their Mortgages

May 5, 2010

More and more homeowners are deciding to walk away from their mortgages voluntarily, even though they can still afford making payments, a new study by the Kellogg School of Management at Northwestern University and the University of Chicago Booth School of Business.

According to the new findings, about 31 per cent of foreclosures in March were considered "strategic defaults," in which borrowers choose to walk away from mortgage obligations when the value of a mortgage exceeds the house value, regardless of their ability to pay. That is up from 22 per cent in March 2009.

The study, that was based on surveys of more than 1,000 U.S. citizens, found that about 56 per cent of homeowners still believed that lenders would not go after them for giving up on the home, which is slightly up from 54 per cent in 2009. The investigators also found that homeowners are 23 per cent more likely to strategically default on their mortgage once their neighbors gave up on their homes. "There is a contagion effect, it is like a disease," said Paola Sapienza, one of the professors who carried out the research. In addition, it was found that strategic default increases by 29 per cent if borrowers can find alternate ways to finance their new home.

Although another study that was released last week by Morgan Stanley does not put the share of strategic defaults this high, the data collected indicates that the trend is growing significantly to about 12 per cent of all defaults in February 2010. Also, Morgan Stanley discovered that the highest proportion of overall defaults is placed in the lowest credit score bucket. However, strategic defaults display a "reverse phenomenon" in both previous loans that were made in 2004 and more recent loans that were made in 2007.

The researchers said that the banks themselves as well as the mortgage services have contributed to the factor that it is "OK to walk away" by not aggressively pursuing delinquent borrowers. According to professor Sapienza, even in recourse states, where banks can legally pursue delinquent borrowers, the evidence shows that they are not doing much.

Defaults by borrowers who owe more than their homes are worth are among the biggest risks for the real estate market, say analysts including Zelman & Associates' Ivy Zelman and Amherst Securities Group LP's Laurie Goodman. In April, the Obama administration announced that to address the issue, it would adjust the government's anti-foreclosure program in order to encourage reductions to homeowners' principal amounts, instead of just the payments they make. This change would give people hope that policy makers are serious about curbing future strategic defaults, the Morgan Stanley mortgage-bond analysts wrote.

Laurie Goodman, mortgage-bond analyst, said that there will be as many as 12 million foreclosures over the next several years unless lenders can effectively modify borrowers' debt. According to real estate Web site Zillow.com, one fifth of homes in the United States that carry mortgages were worth less than their loans at the end of 2009.

Tags: Career & Money