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Strategic default: More than an ethics debate

Strategic defaults and the changing consumer stigma around defaulting on a mortgage make for an interesting ethical debate, argued in media outlets ranging from the Chicago Tribune to The PBS NewsHour. But ethics aside, let's not lose sight that strategic defaults have negative consequences for consumers, servicers and investors.

Consumers who commit strategic default can see a substantial hit to their credit score—as much as 150 points. Lower credit scores not only mean higher interest rates and/or more restrictive terms and conditions for other types of credit, but can affect insurance premiums and a landlord's willingness to accept the consumer as a new tenant. In states that allow recourse, servicers that sell a foreclosed property for less than the amount owed on the mortgage can still pursue the defaulter for the difference. And the consumer's ability to purchase another home is drastically affected: In June 2010, Fannie Mae announced that strategic defaulters will be barred from Fannie Mae loans for seven years from the date of foreclosure.

For servicers, if the trend toward strategic default continues or increases, the result may be that delinquencies and defaults remain at unprecedentedly high levels or even rise again to new heights. That could further tighten access to mortgages and generally put just-now-thawing credit markets back in the deep-freeze.

All consumers, including the majority of homeowners who faithfully pay their mortgages, would suffer from such an outcome. More defaults create more foreclosures, which depress housing prices and consumer confidence, which affect spending and hiring…a downward economic spiral.

Yet there's a great deal servicers can do to help turn the strategic default trend around, by identifying customers who may be considering such action and communicating with them as early as possible. For those interested in learning more, check out the best practices in our latest Insights paper.

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