Disaster

Strategic default: it’s a business decision

According to a December 22 Slate article, strategic defaults on mortgages are on the rise. These mortgage defaults occur when people who could afford to pay their mortgages decide they’ve made a bad investment and walk away. In the current market, a short sale or foreclosure generally follow.

For a large corporation, strategic default is a logical business decision. Companies and very wealthy individuals who can afford to stay current on payments strategically default all the time — and they do so intentionally, once they determine that it’s the wisest financial decision. The number of companies in strategic default doubled last year to nearly 300, the highest on record. These corporations don’t feel guilty about it and they aren’t sanctioned for it because it makes sense logically.

For homeowners, however, strategic default presents a moral dilemma. We’ve been fed the American Dream of Home Ownership since we were children, and giving up that milestone once you’ve attained it feels like a reverse accomplishment. Those of us who value personal responsibility have a difficult time backing out on a contract we truly intended to honor when we signed it. There’s an inherent shame in foreclosure that’s bigger than just the logistical pain in the ass of having to give up your home and move into someone else’s. But all of these things I’ve mentioned are emotional arguments, and as my own CFO, I can’t afford to make business decisions based on emotion.

Last week we learned that Tony’s unemployment will end in less than three months, and at that time we will have lost 50% of our income. We sat down and had some long talks about the future, and finally determined that our best path forward is strategic default on our mortgage. Technically we can still pay it, but within a few months we won’t be able to, and we want to be well-prepared with an exit strategy when that happens. I can’t imagine the stress of riding that roller coaster without a plan, especially as a parent who wants to provide the most stable environment possible for my kid.

Since this is a business decision and we are both project managers, we are approaching this like the management of any other project. First we mind-mapped the concept and then plotted events on a timeline to determine status, goals, possible scenarios, and the effects of different variables. Then we created a revised timeline, outlined a new budget based on reality rather than hope, and assigned the first tasks. We are withholding our first mortgage payment today and banking the cash for a move planned in 3-4 months. We have scheduled a consultation with a friend in real estate, but have already determined that the longer we stay here, the more money we will lose. A little research revealed that we can rent a comparable home for half what we pay for our mortgage, and although some of that will be used to pay down bills, we should be able to save a bit too.

It sucks. I don’t want to move. I’ve never missed a mortgage payment before, and my credit is  very good. I’m feeling some guilt about this. But investing in real estate is always a gamble, and we happened to hit it wrong. We bought when prices were high and mortgages were plentiful, and then the bottom fell out of our income. We’ve maintained for nearly two years, burning through our savings and hoping the situation would bounce back any time. In the meantime, our home value has dropped and our PMI has gone up every year. We have attempted to work with our lender, but were told we don’t qualify for modification. At this point, we need to face the reality that our financial situation may not ever improve, and create a workable plan for the income we actually have. It would sure be ironic if Tony finds a job immediately after we go through all of this, but that will just make our financial situation better. Having more income than we planned on will just help us to finish this project on time and under budget.

Apparently we are not alone. The WSJ article Debtor’s Dilemma: Pay the Mortgage or Walk Away reports that there will be more than a million strategic defaults in 2010. Homeowners who were in reasonable financial condition until the recession now have to make a decision that sucks either way. Although it is happening more frequently, Law professor Brent T. White asserts that most people don’t walk away, even when they are significantly underwater, due to shame and perceived legal consequences of foreclosure. The banks like it that way. The WSJ points out that walking away has definite risks and drawbacks, and offers some things to consider seriously before making that choice.

Strategic default is not to be taken lightly, and can have repercussions — not just on your future ability to get a loan, but also on your neighbors and your community in general. On one hand, you can’t have everyone walking away from their obligations without serious cultural recriminations. On the other hand, if you are on the road headed directly to Financial Disaster, what responsible person wouldn’t want to take a detour and head for a better destination? As the Slate article asks…

“If billionaires don’t feel guilty about walking away from their debts, should homeowners?”

It’s a matter of weighing the risks and benefits to determine the best possible outcome – or at least, a survival strategy that will be the most sustainable over the long term. A cost/benefit analysis, you might say.

 

 

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