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Wednesday, June 1, 2011

Are Banks Encouraging Strategic Default By Lending?

Some banks may be feeding the housing downturn and encouraging strategic default.

An interesting trend is unfolding whereby banks are extending credit to people who have defaulted on their mortgages. The kicker: these defaults are often the only missed payments. This is interpreted to mean that the defaulter is still a good credit risk -- and often is perfectly capable of paying -- but just decided not to pay the mortgage.   (Continued below)

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As in business where many borrowers will default on purpose to squeeze better terms, people are increasingly viewing strategic default as a course of action that risks neither legal consequence nor social stigma. The extension of credit to defaulters means that one can default and still get funded by others, thus removing perhaps the tallest barrier still discouraging people from walking away from loans.

In this corner, anything tending to encourage -- or not discourage -- strategic defaults will risk endangering the housing market even more.

Eric Dixon is a New York investigative lawyer, business consultant and independent energy consultant.  


  1. Banks ARE encouraging Strategic Defaulters, not by extending credit to them later, but by refusing to modify their loans by principal reduction except in extreme hardship.
    Big banks who used very aggressive (and often deceptive) marketing in the boom-years, to sell ARM mortgages with zero-down are now high-handedly expecting homeowners (those who can afford to) to shoulder all the equity loss. Yes, in retrospect it's easy to say the homeowners shouldn't have bought the over-priced homes, but let's not pretend they all went begging banks for those mortgages.
    It's time for the government to FORCE banks to work with severely upside-down homeowners, to realistically bring principals to market value. If they don't, then homeowners SHOULD walk away and let the bank carry its share of the burden. Strategic defaulters (walkaways) do suffer plenty of losses (shame, anxiety, credit loss, legal expenses, moving expenses, loss of home) but not as much as they lose by throwing more money down a mortgage hole that will not be filled for a decade or more.

  2. The motivation for a strategic default may depend on how far a borrower is underwater.
    Having a mortgage that’s twice as much as the value of a home could be somewhat discouraging. The prospect of being stuck with a losing investment that may not reach a break-even point for 10 years or more may be enough motivation to take a walk.