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Underwater mortgage: new term requires new thinking

It's official... the term "underwater"—as applied to a mortgage loan—has made this year’s list of new words added to the Merriam Webster Dictionary. It not only reflects a mainstream recognition of this unfortunate trend, but is also sobering reminder of today’s economic reality: homeowners’ equity has been halved since 2005, leaving more than 15 million consumers underwater on their mortgages, and more than 6.5 million of those 30% or more underwater.

The rub, of course, is that underwater consumers are significantly more likely to consider defaulting on their mortgage. FICO research has found that up to 30% of mortgage defaults are likely to have been strategic decisions to default, given the lack of incentive to continue to keep the mortgage current.

Greater incidences of default, including strategic default, affect consumers, in terms of lower credit scores and less access to affordable credit, as well as mortgage lenders, in terms of losses and increased cost to service the loans. But there are also broader implications, as we’ve seen all too well. It’s economics 101: foreclosures on a broad scale will further depress house prices and consumer confidence, which in turn affects spending, job growth and credit performance. We need to break from this downward cycle.

The answer is to get ahead of the problem, and have lenders and communities work with consumers to find alternative solutions to foreclosure. FICO continues to work with lenders and servicers to tackle default risk proactively. For instance, we’re using predictive analytics to help identify consumers at imminent risk of default—including potential strategic defaulters—early and take appropriate action to avoid the high cost of foreclosure.  By acting early and optimizing the remediation treatment for each borrower, lenders can significantly reduce both default and re-default rates, resulting in a 40% improvement over a traditional waterfall approach to loan modifications.

Approaching this challenge proactively could be a real "game changer"—another new word Merriam Webster added this year.

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