Among the reasons given for the continued rise in number of foreclosed properties are unemployment, subprime lending, adjustable-rate lending and difficult family circumstances such as divorce or hospitalization.
Another major reason is negative equity – home value is less than loan amount. Borrowers who have negative equity, sometimes known as underwater borrowers, often decide to walk out on their loans when their equity gap becomes too big and it becomes senseless for them to continue sacrificing to pay their loans.
According to mortgage data, about one in five homeowners have negative equity. In states where borrowers are not required to pay the shortfall when a house is sold for less than the loan, many borrowers often opt to walk away rather than bear the negative equity.
Even in states where borrowers are liable for shortfall payments, borrowers with big equity gaps allow their homes to become foreclosed properties, hoping that their lenders would not pursue them with the shortfall. Indeed, some lenders often think twice before pursuing unpaid debts because of the cost.
In a study of 1,000 mortgage borrowers who are in different stages of foreclosure, 25 percent said they would choose to intentionally default or allow their homes to become foreclosed properties if they have negative equity. Calling their decision as strategic default, they would do it even if they still have the money to make the monthly payments.
The variety of the responses depended on the extent of the negative equity, the availability and quality of other options and the borrowers’ moral considerations.
Few would decide to make strategic default if their equity gap is less than 10 percent of home value. But one out of six respondents would allow their homes to become foreclosed properties if their mortgages become underwater by 50 percent or more.
Additionally, four out of five think that strategic default is morally wrong. But when the negative equity reaches $100,000, the morality stand wavers. The study also found that more borrowers who are younger than 35 and older than 65 do not believe that strategic default is morally wrong.
The impact of neighborhoods on borrowers’ decision to walk away is also significant. The study found that homeowners in neighborhoods with a lot of foreclosed properties are 82 percent more likely to default intentionally.
In view of the findings, policy makers should address the issue of negative equity when crafting programs to stop the rise in number of foreclosed properties.
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