Strategic Defaults Vs. Hardship Defaults

A Strategic Default is defined as choosing to default on an underwater mortgage even though you can continue to pay it. The Experian credit agency defines Strategic Defaulters as people who default on their mortgage but remain current on all their other non-real-estate debts.

Nationwide, Experian estimates there were more than 1 Million strategic defaults in 2009. In the map to the right, in states shown in red, more than 20% of property sales were strategic defaults.

Hardship Defaults are due to the inability of a homeowner to afford mortgage payments. This could be due to a loan that has reset at a higher interest rate, the loss of income, divorce, new medical expenses, etc. If a home is underwater, and the homeowner has suffered a hardship, there is no question that a short sale is an acceptable solution.

Short sales are also becoming more socially acceptable because government programs like Home Affordable Foreclosure Alternatives (HAFA) encourage short sales as an alternative to failed loan modifications (see Problems with Loan Modifications).

The Ethics of Strategic Defaults

The ethics of strategic defaults trouble many homeowners, and have been the subject of debate. Below is an article by James R. Hager of the Wall Street Journal, dated December 17, 2009, that reviews these issues.

"As we wrote in today’s Wall Street Journal, the plunge in home prices is presenting millions of Americans with a moral and financial dilemma: Should they keep paying their mortgages?

Let’s take a closer look at the moral side of the debate.

We’re talking here about people who choose to stop paying their mortgage not because they can’t afford it but because they think they will be better off financially if they default and move on. That’s called a “strategic default.” And it’s very tempting for some people who don’t have strong ties to their home and neighborhood and whose home value has dropped way below the loan balance. To pay off the loan, they feel, would mean to vastly overpay and destroy their hopes of financial security.

If they stop paying now, they may be able to live in the home “rent free” for another year or more before being ejected by the often-sluggish foreclosure process. Then they will be able to rent a similar home for far less than they’re paying now. Eventually, they may be able to buy another home.

But is that ethical behavior? After all, a standard mortgage-loan document says “I promise to pay” the amount borrowed plus interest. George Brenkert, a professor of business ethics at Georgetown University, says borrowers who can pay—and weren’t deceived by the lender about the nature of the loan—do have a moral responsibility to keep paying.

Of course, plenty of people vow to remain faithful forever to a husband or wife and then end up choosing divorce instead. People who have divorced aren’t generally shunned by our society. Clearly, many Americans do not feel bound forever by even their most solemn promises.

Professor Brenkert won’t let us off that easy. “The fact that we recognize that it’s done doesn’t make it the right thing to be doing,” he says, adding: “There is a lot of rationalization going on.”

Some borrowers argue that they have a moral right to stiff the lender because lenders aren’t doing enough to help borrowers reduce their debt burden, even though some of the lenders have been bailed out by taxpayers. Brent White, an associate law professor at the University of Arizona who has written about this issue, says homeowners should make the decision on whether to keep paying based on their own interests “unclouded by unnecessary guilt or shame.” Lenders do the same thing, he says, when they “ruthlessly seek to maximize profits or minimize losses irrespective of concerns of morality or social responsibility.”

Others note that the lender gets the collateral – a house or condo – and so argue that it’s merely a business  arrangement between consenting adults if the borrower chooses not to  pay.

Kevin T. Jackson, a professor of business ethics at Fordham University in New York, says this isn’t a simple question of right or wrong. Yes, he says, the borrower has an obligation to the lender. But the borrower may have conflicting obligations. For instance, Mr. Jackson says, the borrower may need to consider the long-term needs of his family. “The homeowner is holding onto a failing investment,” Mr. Jackson says. “He also has an obligation to himself and to his family to cut his losses as best he can.”

Learn how Arizona Short Sale Doctor will help you successfully sell your home in a short sale.