More homeowners are choosing to walk away from their mortgage loans rather than make payments on homes that have lost significant value. These strategic defaulters intentionally stop paying on mortgages even though they can afford to make the payments.

The practice has many people debating the ethics of walking away from home loans. Some people see nothing wrong with the practice while others say homeowners who intentionally default are immoral.

Mortgages as Baggage

Strategic defaults have especially risen in Arizona, California, Nevada, and Florida, according to the Wall Street Journal. Those states have high percentages of people underwater on mortgage loans, owing more than their homes are valued at.

Promise to Repay Mortgage Loan

While it may make financial sense to walk away from a home loan, the fact is that anyone who borrowed money signed a promissory note to repay the loan. That promissory note didn’t say pay up unless home values go down or until you get tired of making monthly payments.

Financial Damage

So what happens when homeowners strategically default? First, they end up in foreclosure, and the mortgage lender takes possession of the property. Then their credit scores get hit, plunging as much as 160 points. They also may have other assets seized by their mortgage lender depending upon where they live.

Mortgage Defaults Hurt Community

Strategic defaults don’t just hurt individual homeowners. They also affect the neighborhood where the property is located. Foreclosures significantly impact the property values of surrounding homes. The closer you live to a foreclosure, the more it negatively affects your home’s value, especially if it looks abandoned and poorly maintained.

People who lived withing 300 feet of a foreclosure usually saw their property value drop 1.3%, according to a 2008 study. People within 300 to 500 feet of a foreclosure had a 0.6% drop, according to the New York Times.

Could It Happen Again?

On the positive side strategic defaulters may be able to cut their housing costs while they rent for a while. That could help them save money. But it seems that if these people are willing to renege on a home loan once, they’re likely to do it again in the future if they don’t like the housing hand they’re dealt.

Strategic defaults are likely to continue as more people become fed up with being underwater on their mortgage loans. But anyone who decides to take this step should be prepared for the fallout.

Obtaining a new mortgage loan, auto loan, or other types of credit is going to be tough for years to come. They also may feel disapproval from other people who faithfully continued paying on their home loans even though they are underwater too.

This week’s mortgage news reflected something of a tug-of-war about what consumers should be doing in the face of the recession:

• Mortgage rates edged down yet again, with 30-year rates dropping to 5.47%
• Speculation was that the government would pursue policies to drive mortgage rates even lower
• Existing mortgages continued to experience trouble, as late payments and foreclosures rose to record territory in the third quarter
• Meanwhile, Americans worked to get control of their debts, as consumer debt levels fell on an absolute basis for the first time on record during the third quarter of 2008

The first two items reflect the hope that consumers can be induced to start borrowing enough to spend their way out of recession. The second two items reflect the grim reality that underlying this recession is a debt problem that has to be addressed before the economy can get healthy again.

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Today’s Riverside Press-Enterprise ran a story that should concern all of us. Homeowner Fraud Exacerbates the Mortgage Crisis hit it right on the head. The article detailed numerous ways that homeowners defraud mortgage lenders and run down their own neighborhoods by dumping their homes. These people aren’t down on their luck; they just see a chance for a quick buck and don’t have a problem with everyone else bearing the brunt of their investment choices.

But what is most alarming is the fact that state and local governments in California and Oregon make it very difficult for lenders to get their money back, even if the homeowner committed fraud or could afford to honor his / her obligations.

According to writer Leslie Berkman, “wrongdoers are further insulated by California law, which greatly restricts a lender’s ability to sue borrowers to collect the money they’ve lost in a foreclosure or short sale.”

And those who are supposed to protect us from fraudsters are apparently more interested in playing politics. Despite the fact that according to the FBI the vast majority of home loan fraud is perpetrated by homeowners against lenders, local district attorneys are more interested in appeasing voters and “protecting” them from big bad banks. For example, Larry Roberts, who heads the real estate fraud unit of the San Bernardino DA’s office, indicated they have little interest in prosecuting homeowners who lie to their lenders to get loans. His office is more interested in prosecuting “scammers who profit by deceiving consumers…than it is in catching consumers who defraud a lender with the intention of buying or keeping a home.” Makes a nice commercial but what is really affecting real estate and the economy is the big fraud, the one no one wants to be seen going after, the rip-off engineered by “regular folks.”

So the fraudsters can trash our neighborhoods and make it more expensive and difficult to get home financing–as long as they continue to vote. We need to put the pressure on officials to force the deadbeats who are not insolvent to make good on their mortgages. And we need to bring back the stigma of foreclosure–blowing off your mortgage isn’t cool or cute or clever. It’s as much stealing from the little old lady down the street as if you held a gun to her head and emptied her purse.

The past week saw more symptoms that the mortgage crisis is likely to drag on: 

• Stocks in mortgage financers Fannie Mae and Freddie Mac took a tumble, as investors questioned their long-term viability
• The problems of Fannie Mae and Freddie Mac are already evident to mortgage borrowers in the form of higher fees, tougher approval standards, and higher interest rates
• Mortgage experts warned that the impact of so-called “liar loans” has yet to fully play out
• Not surprisingly, with these and other woes, mortgage application volume continued to slip

For prospective homebuyers, these symptoms of long-term consequences of the mortgage crisis signal that waiting for the storm to blow over may not be the best strategy.

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News trickling out of regulatory offices and lending institutions indicates that the much-touted HUD foreclosure prevention program set to begin in October has hit a few snags. According to American Banker, it is likely that regulatory agencies will not be prepared to begin handling the cases by October 1. In addition, it is expected that this program will meet with the same very limited success that FHASecure did, and for the same reasons.

The biggest obstacle is that loan servicers–those who buy the loan from the original lender and then collect the payments–are the ones foreclosing and are not in a position to originate a new loan as required  by the program. And of those who are licensed and staffed and capable of originating loans, many do not have FHA licenses which are required by law in order to originate an FHA mortgage.

So if you are counting on a rescue to get you out of a home foreclosure in october, don’t. the only thing you can count on most likely is more red tape.

Mortgage news was dominated by two items this week:

• President George W. Bush signed the mortgage relief bill, designed to help troubled home owners stave off foreclosure
• A prominent home price index reported a 15.8% decline for the year ending May 31, 2008, the biggest year-over-year decline so far

On the surface, the first would seem to be a highlight, and the second a lowlight, of the week’s mortgage and housing news. Reading between the lines, though, reveals that the first item may not be as good as it’s been reported, but the second item may not be as bad.

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It was an ugly headline, even by the standards of the mortgage crisis:

• “US foreclosure filings surge 53 percent in June“

Looking a little closer though, it turns out the numbers aren’t nearly as bad as that Associated Press headline would suggest. Another example of the media piling on with a negative spin was a story suggesting that loan modification programs were simply extending mortgage pain.

Meanwhile, there were two positive signs for the mortgage market:

• Mortgage application activity rose for the second consecutive week
• Mortgage rates eased a bit in early July, after rising significantly in June

In large part, the conclusion drawn from the above depends on whether one is taking a forward-looking or backward-looking view of the market.

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Mortgage news this week painted a picture of a variety of ways people are attempting to cope with the mortgage slump:

• While the housing bill continues to meander its way through Congress, it apparently was not an urgent enough issue to get done before Congress adjourned for its Fourth of July recess
• Hope Now, a mortgage industry alliance, reported that it helped 170,000 homeowners avoid foreclosure in the month of May
• Further evidence that falling behind on a mortgage need not be permanent was seen in the fact that more that 40,000 borrowers who had been behind on their mortgages caught up in May
• The week ending June 27 offered a small sign of broader resiliency in the mortgage market, as mortgage application volume recovered slightly from the year-to-date low set during the prior week

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What’s striking about recent mortgage news is how much of it is dominated by stories about investigations and indictments related to mortgage scams. Federal authorities have announced a nationwide crackdown, and local authorities have been active in many communities as well.

There were other, less dramatic stories on the mortgage front:

• Mortgage application activity stalled as mortgage rates rose
• The Hope Now Alliance, a mortgage industry group, announced plans to help streamline work-out plans for troubled borrowers
• A long-awaited mortgage bill became bogged down in the Senate due to controversy stemming from favorable mortgage rates received by two Senators

These other stories are worth reviewing, but ultimatly they are best put in context by the crackdown on mortgage scams.

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Even though stocks have rallied lately on improved economic news, mortgage foreclosures continue to hang like a cloud over the scene.

• An easing in unemployment gains and solid May reports from major retailers were the latest items that suggested the economy was continuing to avoid recession
• On the flipside, a mortgage report for the first quarter of 2008 showed that foreclosures and delinquencies continued to rise
• The foreclosure crisis was given its latest human face when it was reported that celebrity Ed McMahon was struggling to keep his mansion out of foreclosure
• Meanwhile, without fanfare, ten-year Treasuries ended May with a yield above 4.0% for the first time this year — a possible portend of higher mortgage rates to come

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