Risk of Strategic Default Rising in Low-Risk Areas

Negative equity remains one of the biggest challenges for the housing market. For some borrowers it can become their rationale to stop making mortgage payments and intentionally default on the loan.

The risk of such strategic default is rising among loans that have “always performed,” according to the credit analysts at Moody’s Analytics.

They say as home prices have fallen over the past year, the loan-to-value ratios (LTVs) of so-called always-performing loans – or those that have remained current – have begun to approach, and in many cases surpass, average LTVs for loans that have defaulted.

This dynamic, Moody’s says, raises the likelihood of a renewed increase in strategic defaults.

The agency found that these always-performing loans tend to be concentrated in markets that have held their values above the national average, namely the robust housing markets in the Los Angeles, New York/New Jersey, Washington D.C., and Chicago metropolitan statistical areas (MSAs).

Since mid-2010, Moody’s study shows that the average home price for current loans originated since 2005 has been falling, precipitating rising LTVs that are now approaching the LTVs of loans that have defaulted since 2009.

The agency’s analysts point out that this is a departure from what they’ve seen up until the middle of last year, during which LTVs for what they refer to as always-performing loans had stayed flat or even slightly decreased due to generally stable home prices above the national average.

“We have found that between 12 percent and 24 percent of always-performing loans, depending on the asset type, exhibit LTVs that are higher and have risen more steeply than those of defaulted loans,” the analysts wrote. “These loans…are particularly likely to be subject to a strategic default in the near term.”

The rising LTVs of current loans are reminiscent of loans that have defaulted over the past two years, which typically featured LTVs that not only were high at default but had also been steadily trending upward for at least the year prior to default amidst declining home prices, Moody’s explained.

“The fact that increasing LTVs have usually preceded default indicates that the defaults likely represent economic decisions to stop paying on mortgages where balances far exceed property valuations,” according to Moody’s analysts.

They added, “Rapid rates of LTV increases may themselves be a factor in a borrower’s decision to strategically default, since they may quickly erode any remaining confidence in borrowers that they could ever restore positive equity in their property.”

The analysts at Moody’s expect home prices to continue to decrease modestly through the first quarter of 2012, subjecting always-performing loans to further increases in LTVs over the near term and higher risks for strategic default.

This entire article is by DSNews.com, and is viewable at: Moody’s Sees Risk of Strategic Default Rising in Low-Risk Areas.

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One Comment

  1. Strategic default will remain an elevated risk until home values start moving upward again. Negative equity, as you mentioned, is the main driver; for many people it doesn’t make financial, or lifestyle, sense to maintain good standing on their loans. This is especially true when you mix negative home owner equity with poor labor market conditions…something’s got to give for markets to return to a healthy equilibrium.

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