strategic default



A strategic default is the decision by a borrower to stop making payments (i.e., to default) on a debt, despite having the financial ability to make the payments. This is particularly associated with residential and commercial
mortgages A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any pu ...
, in which case it usually occurs after a substantial drop in the house's price such that the debt owed is (considerably) greater than the value of the property — the property has negative equity or is ''underwater'' — and is expected to remain so for the foreseeable future, such as following the bursting of a
real estate bubble A real-estate bubble or property bubble (or housing bubble for residential markets) is a type of economic bubble that occurs periodically in local or global real-estate markets, and typically follow a land boom. A land boom is the rapid increase ...
. Such borrowers are called ''walkaways''. The process of strategically defaulting on a home mortgage has been colloquially called "jingle mail" — metaphorically, one mails the keys to the bank.

Prevalence post-housing bubble

Paul Krugman Paul Robin Krugman ( ; born February 28, 1953) is an American economist, who is Distinguished Professor of Economics at the Graduate Center of the City University of New York, and a columnist for ''The New York Times''. In 2008, Krugman was th ...
and Hal Varian argued that strategic default would be an inevitable result of the collapse of the finance and property bubble of the era following 2006. They also noted that this is one of the few ways of freeing people from the burden of mortgage debt. Once free of the mortgage, debtors are free to use their income for other expenditures. A study in September 2009 from the credit reporting agency
Experian Experian is an American–Irish multinational data analytics and consumer credit reporting company. Experian collects and aggregates information on over 1 billion people and businesses including 235 million individual U.S. consumers and more ...
and consulting outfit
Oliver Wyman Oliver Wyman is an American management consulting firm. Founded in New York City in 1984 by former Booz Allen Hamilton partners Alex Oliver and Bill Wyman, the firm has more than 60 offices in Europe, North America, the Middle East, and Asia-P ...
estimated that close to a fifth of troubled mortgages in the U.S. involved borrowers who were strategically defaulting.


Effects vary by jurisdiction; different countries and different states in the United States treat default on mortgage debt differently, notably distinguishing whether it is recourse debt and non-recourse debt, meaning whether the mortgage lender can pursue claims against the defaulted debtor. Further, mortgage
refinancing Refinancing is the replacement of an existing debt obligation with another debt obligation under a different term and interest rate. The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic ...
may be treated differently from an original, un-refinanced mortgage, and mortgages on second homes may be treated differently from mortgages on primary residences. The borrower after deciding to not make payments any more can live free of the costs of payment or rent until the lender forecloses, which may take from several months to years. A borrower may use this time to extinguish or negotiate other debt. Mortgage lenders may negotiate with defaulting borrowers to assure maintenance and occupancy of the property until the lender can take title and market the house, and may provide the defaulting borrower with greater than the minimum legal notice to quit (which can be as little as three days) and may even agree to pay a fee to leave the home in pristine condition. Foreclosure of the borrower's house will result in a negative entry on the borrower's
credit rating A credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor defaulting. ...
, possibly making obtaining loans in the future more difficult or more expensive for the borrower. With otherwise good credit a new mortgage from US government agencies will be denied until 3 (FHA) to 7 years (FNMA) have passed since the actual date of foreclosure. The difference between the value of the property at the time of foreclosure and the amount of the note (assuming the note is larger) is considered by the IRS as "debt forgiven" and may be considered "income" subject to federal income tax. For a short period ending at the end of December 2012 due to the Mortgage Forgiveness Debt Relief Act of 2007, this "phantom income" was not subject to tax on primary residences.

Ethical issues

Some ethicists have questioned the morality of strategic default, arguing that one has a ''duty'' to make payments on debt if one is able. Others argue that there is no such moral duty, a loan being a contract between consenting adults, and noting that financial investors routinely default on non-recourse loans that have negative equity. Some argue further that there is a moral duty to strategically default, and that one should make such decisions based on one's financial interest "unclouded by unnecessary guilt or
shame Shame is an unpleasant self-conscious emotion often associated with negative self-evaluation; motivation to quit; and feelings of pain, exposure, distrust, powerlessness, and worthlessness. Definition Shame is a discrete, basic emotion, d ...
", as lenders who do not modify mortgages do the same, "seek ngto maximize profits or minimize losses irrespective of concerns of
morality Morality () is the differentiation of intentions, decisions and actions between those that are distinguished as proper (right) and those that are improper (wrong). Morality can be a body of standards or principles derived from a code of con ...
or social responsibility," or more bluntly stating that "The economy is fundamentally amoral." Further, obligations to honor a contract are balanced by obligations to oneself and one's family, the latter speaking in favor of strategic default, some arguing "You need to put yourself and your family's finances first," while one also has obligations to a community, which may be damaged by default.

Other jurisdictions

In Europe, there are generally no pure
nonrecourse debt Nonrecourse debt or a nonrecourse loan (sometimes hyphenated as non-recourse) is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defa ...
s for private persons. Therefore, they need to pay remaining debts even if leaving their houses. Because having a home to sleep in is prioritized, the house mortgage is usually prioritized, while other debts might be abandoned if they cannot be paid. Strategic bankruptcy of companies is however common in Europe.

See also

* Bank walkaway, opposite situation where bank walks away *
Strategic bankruptcy A strategic bankruptcy may occur when an otherwise solvent company makes use of the bankruptcy laws for some specific business purpose other than simple inability to pay debts. Introduction In the U.S., Chapter 11 bankruptcy made it possible f ...
, corporate analog


External links

The Menace of Strategic Default, ''City Journal,'' Spring 2010

* ttp:// Moral and Social Constraints to Strategic Default on Mortgages (pdf)br>Home Foreclosure and Debt Cancellation
IRS The Internal Revenue Service (IRS) is the revenue service for the United States federal government, which is responsible for collecting U.S. federal taxes and administering the Internal Revenue Code, the main body of the federal statutory tax ...

American Dream 2: Default, Then Rent

by Don Bisenius,
Freddie Mac The Federal Home Loan Mortgage Corporation (FHLMC), commonly known as Freddie Mac, is a publicly traded, government-sponsored enterprise (GSE), headquartered in Tysons Corner, Virginia.HomeLiberty offers ‘strategic defaulters’ chance to keep homes
''San Francisco Business Times,'' Mark Calvey, May 23, 2011

{{Real estate Mortgage Debt Foreclosure