Strategic defaults, a Chapter 11-esque move in which homeowners walk away from their property and stop paying their mortgage, are happening with increasing regularity in today’s housing market, and if current legislation is any indication, they are happening much to the chagrin of the financial sector.
According to a recent article by National Mortgage News, a House Financial Services subcommittee has recently begun review of a Federal Housing Administration (FHA) reform bill, and a number of trade groups are lobbying to add provisions to the bill that would discourage homeowners from strategically defaulting.
The inherent features of the bill deal with premiums and indemnification on FHA loans. Currently, no statutory requirement exists for the FHA to charge annual premiums on loans, and the bill would force the FHA to charge a minimum annual premium of 55 basis points, or bps. Annual premiums would be capped at 205 bps.
In addition, the bill would require the FHA to “review the cause of every loan,” as the article put it, that becomes 90-days delinquent within 24 months of its origination, as well as seek indemnification when “material violation” of the agency’s underwriting standards result in losses.
None of those provisions had attracted much attention, but a recently suggested amendment by the National Association of Federal Credit Unions (NAFCU) on strategic defaults may prove controversial.
The NAFCU amendment would increase the FHA’s lockout from three years to seven; so, when a homeowner defaults on a GSE loan, they would no longer be able to qualify for FHA financing three years after the initial default, but would have to wait for seven years, just like what Fannie Mae and Freddie Mac mandate in their regulations.
Becker contends that the amendment would “ensure the FHA is not propped up to be a safe haven for those who strategically default on previous mortgages,” according to the article.
As we reported last month, strategic defaults have become an increasingly attractive option for underwater borrowers. The logic goes like this: though they can still afford their mortgage, it makes little sense for the borrowers to continue paying for a home they will reap no profit from for, potentially, the next decade, given the 33 percent drop in home values since 2005; as a result of that realization, they strategically default, walking away from the property and refusing to pay their loans.
Though it seems an unorthodox strategy compared to loan modifications or refinancing, a recent survey by Paola Spienza and Luigi Zingales, two Chicagoland professors of finance, found that roughly three out of 10 mortgage defaults in 2010 were of the strategic bend, which was a 22 percent increase from 2009, and national movements have erupted in recent years urging homeowners to strategically default.
2012 is still young, so there is no data out yet on the progress of such movements or the current trends of strategic defaults, but it is safe to say, based on the efforts of the NAFCU, that it has lenders’ attention.
UPDATE: The bill in question passed the House subcommittee late on Wednesday, apparently without the lockout provision.