Strategic Default

What Is a Strategic Default?

A strategic default is a deliberate decision by a borrower to stop making payments on a debt. The decision is made by the debtor, not the lender.

The strategic default option is sometimes chosen by mortgage holders of residential or commercial property who have analyzed the costs and benefits of defaulting rather than continuing to make payments and have found it more beneficial to default.

Key Takeaways

  • A strategic default is a decision by a borrower to stop repaying a mortgage obligation.
  • The decision is typically made when the market value of a property has fallen below the amount due on the mortgage.
  • Rather than waiting for conditions to change, the mortgage holder walks away from the property and the debt.

Understanding Strategic Default

The borrower who strategically defaults typically has a mortgage on a property that is "underwater." That is, the property is worth less money if sold than the borrower owes on the mortgage. In many cases, the person or business who strategically defaults is in some financial distress and is unable or unwilling to stick it out until market conditions or their own financial situations improve.

Therefore, the borrower may decide that strategic default is a better financial decision than continuing to pay the mortgage. It is a way for property owners to cut their losses when the value of their property drops below the amount they owe on it.

Bankers call homeowners who use this strategy walkaways. The process of performing a strategic default is commonly called jingle mail, as walkaways typically mail their keys to the bank when they abandon their properties.

"Jingle Mail"

Lenders' jargon for keys to properties that are sent back to the bank by defaulting mortgage holders.

Who Uses Strategic Defaults?

Strategic defaults by individual homeowners were common in the years following the bursting of the U.S. real estate bubble in 2006-2007, and the Great Recession that followed it. They remained common for some years after, particularly in the hardest-hit regions where home values failed to recover fast enough to free many debtors from the burden of negative equity.

In tough economic times, strategic defaults also are common among business and corporate borrowers who see the value of investment properties plummet. For example, in 2010, real estate developers Tishman Speyer Properties and BlackRock Realty strategically defaulted on mortgages worth $4.4 billion that they held for two Manhattan apartment complexes. The properties had dropped in value by more than half.

Consequences of Strategic Default

Strategic default can be a last resort for a debtor who is in severe financial distress. It can offer an escape from a downward spiral, freeing the debtor from an overwhelming obligation. Inevitably, it also causes substantial damage to the strategic defaulter’s credit rating. A mortgage holder could lose up to 160 credit points as a result of strategic default.

Debtors who are not already in financial distress can plan for strategic default by saving money, opening new credit cards, or taking out a new car loan or even a mortgage on another property before opting to strategically default.

Defaulting on commercial property has a similar impact on a business or investor. A history of default makes it more difficult and more expensive for the business to get new credit.

What Are Some Alternatives to a Strategic Default?

If your home is underwater and you cannot afford your mortgage payments, a strategic default may make sense; but there are some other options you might want to first consider. See if your lender will work with you to refinance to renegotiate or modify your mortgage terms (e.g., via a process known as forbearance). A short sale is another option that allows the homeowner to sell the property for less than the market value in order to satisfy the mortgage.

Can I Buy Another Home After a Strategic Default?

A strategic default can make it much more difficult to obtain a new mortgage. First, your credit score will go down by quite a bit, making you less attractive to lenders. Fannie Mae has further imposed restrictions on those who strategically default, making them ineligible for a new Fannie Mae-backed mortgage loan for a period of at least seven years from the date of foreclosure.

What Percentage of Mortgage Defaults Are Strategic?

The number of strategic defaults will vary based on the state of the economy, local housing market, interest rates, and so on. In the wake of the 2008-09 financial crisis, walking away from one's home became increasingly common. Still, research has shown that during that period, only about 10% of all defaults involved those who were able to but unwilling to pay.

The Bottom Line

Strategic defaults occur when a borrower stops making payments on a debt. While it was commonly used during the real estate bubble and great recession, this strategy is considered a last resort. It can have significant negative impacts on your credit and ability to borrow in the future.

Article Sources
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  1. Morgan Stanley. "ABS Market Insights Understanding Strategic Defaults," Page 2.

  2. Ernie Jowsey. "Real Estate Economics," Page 134. Palgrave Macmillan, 2011.

  3. Federal Reserve Bank of Philadelphia. "Working Paper No. 11-3 Strategic Default on First and Second Lien Mortgages During the Financial Crisis," Pages 1-3 and 20-21.

  4. U.S. Government Publishing Office. "Congressional Oversight Panel February Oversight Report*."

  5. Fair Isaac Corporation. "FICO Analysis: Strategic Default Problem Grows."

  6. Fannie Mae. "Fannie Mae Increases Penalties for Borrowers Who Walk Away."

  7. Bradley, Michael G., Amy Crews Cutts, and Wei Liu. "Strategic mortgage default: The effect of neighborhood factors." Real Estate Economics, Vol. 43, No. 2. 2015, pp. 271-299.