They come from all walks of life. From the guy next door, to celebrities, to even large prominent companies, strategic default is a growing option for more and more borrowers to take. The exact amount of strategic foreclosures is unknown but a recent study by the Federal Reserve Board showed that half of the home owners who walked away from their homes owed twice as much as it was worth. Throwing morals out the window, strategic default for some essentially becomes a business decision.
Strategic defaults are home owners whose home value has dropped so drastically the borrower decides to stop paying the mortgage and walk away from the property, even though they can afford to make the payments. With the current long timelines from the point of default until the point of foreclosure, many borrowers can stay in their homes for up to two years, without having to pay a cent!
And you think it’s just the working man? Oh no. In fact, delinquency rates with loans over $1 million are higher than rates for the average homeowner…one in seven compared to one in twelve. You may drive through Beverly Hills and see all those sleek European luxury cars, but behind those iron gates there are many who have leveraged their balance sheet to the hilt.
The local CBS news station chronicled the trials of a Los Angeles area resident who had purchased an ocean view townhome in 2006 for $1.385 million and after watching the value steadily drop to “less than $800,000, maybe less,” stopped paying on his mortgage.
“I haven’t made a payment in two years,” he says. “It was business decision. It was an easy decision. I have a property worth six or 700,000 less than when I bought it. I was making payments of 10,000 a month.”
“People like myself, business people, are thinking it is silly to throw good money after bad,” he added. “The loss is not mine. The loss is the banks.” Well not quite, it’s the taxpayer who pays in the end.
As of February 1st, the Multiple Listing Service (MLS) officially listed only four foreclosed homes for sale in the Beverly Hills area, yet there were 149 homes with default notices of which 107 had estimated mortgage balances of over $1 million. Almost makes you want to line up at the courthouse to get in on the great deals.
But it’s not just the rich Beverly Hills players who have been hit hard by the housing crisis, even Morgan Stanley walked away last year from a $1.5 billion mortgage on five buildings in San Francisco despite record-breaking profits in 2009. I wonder how big the bonus was for the guy who masterminded that purchase.
The stigma attached to strategic defaults always weakens during housing downturns. We saw it during the last housing downturn, but are seeing it far more this time around as the housing crisis is the most severe in 80 years.
Luigi Zingales, an economist and professor at the University of Chicago’s Booth School of Business says, "Once you think it's socially acceptable, it becomes easier to do.”
Such is the life of the rich and maybe not so famous.
Next…foreclosures of the Housewives of Orange County. Let’s not go there.
Tags: strategic defaults, foreclosure, mortgage borrowers, home values, housing crisis
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