ForeclosureGene Kessler, 67, may be the new face of mortgage default. The tech industry retiree is in the process of walking away from the home he purchased for $166,000 in 2004 in a small town 75 miles southwest of Minneapolis.

Its value has plummeted to $111,000, wiping out Kessler's $45,000 down payment and leaving him with a mortgage that's more than the home is worth. He stopped paying the loan six months ago, and estimates he'll have to vacate by March 2012.

But Kessler isn't in financial trouble, and he could afford the monthly payments. He has no other debts and two pensions from former employers, as well as Social Security. He also has a woodworking hobby, and runs a small business selling the artisan lamps he makes in galleries. He's single now, and his two children are grown and gone.

"I was looking for a way to get back to a larger city, and this was the only way I could get out of this house," says Kessler, who paid $800 to YouWalkAway.com to help guide him through the process known as strategic default. He's anticipating a move to a warmer climate and a more active art and dating scene in Santa Fe, N.M.

Banks Hit the Restart Button on Foreclosures


First notices of default jumped 33% in August, a nine-month high and the biggest month-over-month increase since August 2007, according to figures by RealtyTrac released Wednesday.

"There are 3 million to 4 million seriously delinquent mortgages that under normal circumstances would be in foreclosure but have been kept out by procedural delays and paperwork problems," says Rick Sharga, RealtyTrac senior vice president. The recent spike in foreclosure starts suggests lenders are "hitting the restart button" on cases that were delayed by documentation problems such as robo-signing, he explains.

There's no data on the demographics or financial histories of the people receiving recent default notices. But among them are some homeowners who have never defaulted on a loan before, at least according to one poll. YouWalkAway.com surveyed several hundred of its clients earlier this year, and just 23% said they had previously shirked a financial obligation.

"The people we are now seeing are nearing retirement age, who never missed a payment on anything in their lives," says Jon Maddux, co-founder and CEO of the Carlsbad, Calif., firm. "They are trapped. They can't sell or get a modification and they need to downsize or move for a job."

Attitudes toward default have also shifted, Maddux says. "Back in 2008 people were very emotional, very scared, in disbelief or denial," he says. "Now they are simply fed up. It's a very calculated, black-and-white business decision. People feel very relieved."

Putting a Crater in Your Credit Score


A more widespread understanding of the consequences of default may be a factor, says Brent White, a University of Arizona law professor and author of Underwater Home.

"The conventional wisdom is you are ruined and are not going to recover," says White, who wrote a widely circulated discussion paper on the topic. But in so-called "non-recourse" states such as California, the bank can only foreclose on the property and resell it. If the price is less than the amount owed on the mortgage, the lender can't sue the homeowner to recoup the shortfall, says White. Even in recourse states, the bank is unlikely to go after the homeowner following foreclosure, he argues.

"The vast majority of those who default end up doing a short sale and that discharges the deficiency," he says. "If they are pursued, they can negotiate to pay less than the full amount. A savvy person who retains an attorney or other knowledgeable person to walk them through the process will likely get through default without having to pay a deficiency judgment. Most people will have a good credit score again within a couple years."

But John Ulzheimer, president of consumer education for SmartCredit.com, disagrees, at least for consumers new to default. "If someone who has never missed a payment suddenly puts their home in foreclosure, their credit score is destroyed," says Ulzheimer, who previously worked for a credit bureau.

"If you already have payment problems on the mortgage and defaulted on other accounts, [foreclosure] may not have a material downward impact, but it will lock in a lower score for a long time," Ulzheimer says. People who stop paying the mortgage can minimize the credit score impact by using that free cash flow to pay down other debts, such as credit cards, he adds.

Refusing to Walk Away From a Bad Loan


But just because the bank doesn't pursue homeowners today doesn't mean it won't tomorrow, argues Ulzheimer. The statute of limitations to sue on contract debt in recourse states ranges from three to 15 years. "Some people think that's the next shoe to fall," he notes.

That possibility is just one reason other underwater homeowners are stubbornly hanging on. Liana Friend, 67, bought a two-story, 2,300-square-foot home with a pool in a master community in Corona, Calif., in July 2005 as an investment for $540,000. It's now worth $295,000.

Friend owes $389,000 on 30-year mortgage at 6.75% that can't be refinanced. The difference between her costs and the rent she can collect on the property is about $1,300 a month. Even Friend's property manager has suggested she default on the investment.

But she refuses. "It's a big time moral issue," says Friend. "If you make a contract, you agree to the terms. It bothers me that people get up and walk away. I don't want that on my credit report."

Moreover, Friend made a $160,000 down payment using money inherited from her grandparents. Her grandmother was a self-taught investor from a farming community who married her first husband (of five) at age 14 and eventually made a fortune in stocks. "She would grab all the granddaughters in her pink Cadillac and take us shopping," Friend recalls. "We were not allowed to take things in shopping bags -- she insisted we had to have them in boxes. We all adored her."

"I love and believe in real estate," adds Friend, who purchased two other homes in the 1980s that are still worth far more than she paid. She bought the properties for income in retirement, and plans to bequeath them to her three daughters.

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Friend should ask her lender how far the mortgage needs to be paid down in order to refinance, advises Keith Gumbinger, vice president at HSH Associates, a mortgage information publisher. He estimates she would need $160,000, possibly more, to do a cash-in refinance on the property. But even if she could refinance, it still wouldn't fully close the shortfall between the rent and her costs, and it may take decades for the house to recover its value.

White says underwater homeowners should figure out if they are paying substantially more to own a house on a monthly basis than they would pay to rent a similar property. "Even if you are thousands of dollars underwater, if you are paying the same as you would to rent, you don't gain that much financially by defaulting," he says. (The survey by YouWalkAway.com found a quarter of respondents saved 50% or more on housing expenses when they rented after their default.)

In addition, someone who will need a good credit score to run a small business or borrow to meet a goal, such as a child's college education, should avoid strategic default. "If you have a particular need for easy credit in the future, then it doesn't make financial sense," White notes.

As for Kessler, he is looking forward to biking, tennis and skiing in the Southwest next year. "I don't feel guilty at all about walking away from the place," he says. "The banks really did it to themselves. They made a ton of money with me over the years. I owned four or five houses. But I don't think I'll ever buy another house. I'll probably just rent until they put me in a nursing home."

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September 17 2013 at 6:37 AM Report abuse rate up rate down Reply
Tom

If I were underwater and needed to relocate, I'd strategic default too. There's no point in allowing yourself to be chained to a location/house you don't want to be in just to "honor the contract". It was a busted/bad investment for the bank/homeowner. Write it off and move on. It's like buying a stock that crashes and burns without hope for recovery. Sell it and move on. Staying the course is simply irrational.

The banks/gov really needs to come up with a solution to this problem. Strategic default is such an obvious recourse in the face of an underwater house, but with the need to move (for job or other reason). You may find it immoral, but there is no hope for these people -- the job market is NOT going to recover and more of this *is* going to happen.

September 21 2011 at 4:53 PM Report abuse rate up rate down Reply
jlbno1

If you cannot make your mortgage payment because of financial distress, I sympathize with you. If you walk away from a real estate deal because the property no longer has the same value, but you have the finances to still pay the debt but choose to walk away. THAT MAKES YOU A DEAD BEAT. Fannie Mae or Freddie Mac, both owned by the tax payers should garnish the dead beats social security payments for walking away from the mortgage he can pay. More than likely Fannie and Freddie own that loan.

September 20 2011 at 10:56 AM Report abuse rate up rate down Reply
keepergo

I FOLLOWED ALL THE RULES AND SIGNED THE CONTRACT. THEY FELL THRU ON THEIR OBLIGATION TO ME AS A SERVICER.

September 20 2011 at 10:42 AM Report abuse rate up rate down Reply
keepergo

Let me tell you what a criminal is. Making a mistake on an esrow calculation. Foreclosing on a home. Admitting to the mistake and still foreclosing. That is criminal. And what is being done about it? NOTHING.

September 20 2011 at 10:37 AM Report abuse rate up rate down Reply
THECORBYS

IF YOU DON'T PAY YOUR MORTGAGE FOR 6-12 MONTHS,YOU MAY FIND THE BANK WILLING TO REWORK YOUR LOAN AND EVEN REDUCE THE PRINCIPAL. I'VE SEEN CASES WHERE THE BANK DID NOT WANT THE HOUSE BACK AND THEY REDUCED THE PRINCIPAL BY 200,000.00 ON A 700,000.00 LOAN.

September 20 2011 at 10:04 AM Report abuse rate up rate down Reply
niceguy71653

I'm really tired of the people who used the real estate market, variable rate loans and anticipated future price inflation to buy more hosue than they really needed or could afford. Or they took out home equity loans to buy second homes, boats, expensive cars, etc. None of the lenders held a gun to their heads and made them take the money, and now they want them or the government (hint: you and me) to pay for their greed and stupidity.

Yes, the banks should not have made somee of the loans, but in the end it was borrowers making a decision to borrow money t hat they cannot/do not want to repay. I have no sympathy for any of them, unless the reason they are not paying is because they have lost their jobs. That's not what this article is about, it's about strategic defaults. They should be illegal, as they are in Europe. You take the money, you pay it off, even if it takes you (and, in Europe, your heirs) the rest of your life and their lives. If that was the law here, people would be much more cautious about taking on debt.

September 20 2011 at 9:48 AM Report abuse rate up rate down Reply
2 replies to niceguy71653's comment
Mickylitz

Well said Nice guy.

September 20 2011 at 10:27 AM Report abuse rate up rate down Reply
enforcer

Unfortunately for you this is not Europe. It is amazing how you "holier than thou" types use examples to suit your need. Europe is also considered socialist in many ways, do you want that too? I can't believe this nonsense on putting the blame squarely on consumers. Listen to you chastise folks who took out more than they can afford. I didn't hear you address the fact that many were cohersed, deceived and lied to in signing up for the loans. There are those who used the system for profit by flipping, they are all in the numbers. Don't give an uneducated opinion when you do not know the facts!

September 21 2011 at 11:01 AM Report abuse rate up rate down Reply
Carl

This is criminal. It is hard to believe that our current society is so accepting of this. How did we get in this situation in the first place? If there were more serious consequences then fewer people would be walking away from their homes, and thus the decline of home values would be thwarted. A home is an investment - all investments have risks. Grow up people! The moral decline has consequences....

September 20 2011 at 9:39 AM Report abuse rate up rate down Reply
1 reply to Carl's comment
enforcer

Likewise if there were more regulations the banks would not dare approve such loans, which leads to less money for them. Get it!

September 21 2011 at 11:03 AM Report abuse rate up rate down Reply
1 reply to enforcer's comment
Sean Fitts

Actually enforcer it was the government regulations that "made" the banks do loans they would not have normally approved. Look up "community reinvestment act". It's not the whole reason, greed eventually found its place in this too, but this mandate on banks was already government ENFORCED for them to do bad loans.

September 22 2011 at 7:50 AM Report abuse rate up rate down
kob1955

Why is it your house drops in value, but property taxes, but local governments refuse to adjust the tax rate?

September 20 2011 at 9:33 AM Report abuse +2 rate up rate down Reply
1 reply to kob1955's comment
Mickylitz

kob1955

I don't know where you live but here in Nevada in the conservative county our property taxes dropped $ 350 dollars this time around, I hope that people keep up the good work and vote to keep the democrats out to pervent them from digging in our pockets............

September 20 2011 at 10:25 AM Report abuse -1 rate up rate down Reply
mrfrench

This is a country of lazy, stupid and mostly irresponsible people. Ready to blame everyone else for their lack of common sense with regards to finances. They signed a mortgage contract and agreed to all of the terms. Nowhere in that contract was it stated that if the house did not keep increasing in value, you don't have to repay the loan!
Also, there was no clause in that same mortgage contract that stated that if you lost a job, became disabled etc. that you did not have to repay the loan......sorry bunches of deadbeats pimping the system. It seemed nearly everyone had been so wrapped up in "conspicuous consumption" and saving nothing. IDIOTS>>>>

September 20 2011 at 8:39 AM Report abuse rate up rate down Reply
2 replies to mrfrench's comment
Mickylitz

mrfrench

I can't argue with that although I am not so sure about attributing their behavior totally to stupidity, I Think it's mostly a lack of caring as long as they can get WHAT they want WHEN they want and to hell with the rest of the responsible folks, they know that the Liberals will come to their aid by stealing from us.............

September 20 2011 at 8:59 AM Report abuse rate up rate down Reply
enforcer

Looks like mrfrench is the stupid one! Mind over matter my friend! Since when did the financial institutions have a life. Listen to you, even though it has been proven time again that they were reckless, you still squarely blame consumers. We are consumers, that's it! The experts know better, so why did they issue the loans? Greed, abject greed!! I wish everyone can walk away, that way they may wake up and realize we only make money if the American people consume!

September 21 2011 at 11:07 AM Report abuse rate up rate down Reply