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"We're considering stopping our mortgage payments..."
A friend of mine lives in Las Vegas. He and his wife both have safe jobs. They have no kids and no debt. They live in a modest house in the outskirts of the city. Their house has a spare room. They rent it to a friend.
In short, my friend and his wife can comfortably afford their monthly mortgage payment. But they may stop paying anyway...
In most mortgage defaults, the homeowner cannot afford to make the monthly payments. Perhaps he lost his job... or perhaps he has too many bills to pay. For whatever reason, he stops making the mortgage payments and, after a period, the bank reclaims the house.
A "strategic default" is where the homeowner can afford to make the monthly payment but decides he's better off defaulting anyway.
Take my friend as an example. He borrowed $300,000 to buy his house. But it's only worth $200,000 in today's market. So he has "negative equity" of $100,000. As long as he has negative equity, he won't be able to sell his house and he won't be able to refinance his loan at better interest rates. He's trapped in his house, making payments on a large loan.
Defaulting is his second option. He stops making his mortgage payments and waits for the bank to foreclose his property...
Right now, option two is the most attractive to him. He'll be rid of his debt. Plus, he'll get six months "free rent" before the bank kicks him out. The foreclosure will ruin his credit, but it doesn't matter. The blemish disappears from his record in less than 10 years. And in the meantime, his wife can buy a house (the mortgage is only in his name).
It's a buyer's market in Las Vegas, and his wife can buy at a 50% discount to what they paid the first time around. Interest rates have fallen... so they'll have lower monthly payments. And to top it all off, the government is offering an $8,000 tax credit to first-time homebuyers who buy a home before December 1, 2009.
By defaulting on his loan, he'll save himself over a hundred thousand dollars... and still own a home.
"Everyone's doing it," says my friend. "I know three other people who are doing [strategic defaults] too," he says. "They're buying bigger houses with lower monthly payments. And that's just from my work..."
New research this month from the University of Chicago's Booth School of Business and Northwestern University's Kellogg School of Management found strategic defaulting now accounts for 26% of all mortgage defaults. And according to Zillow, a real estate database, 22% of homes in America have negative equity. In parts of California and Nevada, over 50% of homes have negative equity.
With all the negative equity in America, there's plenty of cannon fodder for more strategic defaults. That's terrible news for the banks that hold these mortgages. But it could be great news for you...
If you're interested in property investment or even if you're thinking about moving to a new house, now is the perfect time to start looking. Prices could fall farther from here, but the same system that's making default an attractive choice for my friend is propping up property values.
The $8,000 tax incentive, super-low mortgage rates, and other programs are pouring money into residential real estate. In other words, the government is doing everything it can to create a "floor" for housing. Last week, the benchmark home-price index showed prices on single-family homes rose 0.5% from April to May, the first monthly increase since 2006.
If you can afford it, this is the time to be opportunistic. There are incredible bargains to be had.
Good investing,
Tom
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