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 commonly 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.
- 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.
Lenders' jargon for keys to properties that are sent back to the bank by defaulting mortgage holders.
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.
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 can expect to lose at least 100 points from his or her credit rating as a result of strategic 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.
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.