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Borrowers Ditching Second Homes Through Strategic Default

There is a new trend in foreclosures. More homeowners are choosing to ditch their second homes when the property is worth less than the mortgage balance, even if they are still able to afford the payments. This is known as strategic default, in which a homeowner defaults on the mortgage for a vacation home or investment property, usually resulting in foreclosure.

Why are these individuals choosing not to pay their mortgages when they have the ability to do so? Depending on where the property is located, it may make economic sense for the homeowner.

There are "recourse" and "nonrecourse" states. If the property is located in a recourse state, the lender can come after the borrower for the full mortgage amount in a strategic default situation. However, in nonrecourse states, the lender will have to accept whatever amount the property garners at a foreclosure sale or short sale, and will be unable to sue for the full mortgage amount. Florida is a nonrecourse state, along with Connecticut and Arizona. There are also "single-action" states, which allow a lender to choose between foreclosing or bringing a civil lawsuit against the borrower for the full amount of the loan.

Nevertheless, strategic default is on the rise. A study released this summer by researchers from the European University Institute, Northwestern University and the University of Chicago revealed that 35.6 percent of all foreclosures were strategic defaults as of last March. This is a substantial increase from 23.6 percent only one year prior.

Although some have argued that strategic default is unethical, it is not illegal. While this method can make economic sense for many homeowners, their credit will still be impacted by foreclosure.

Source: The New York Times "When Borrowers Default on Second Homes," Lynnley Browning, 2 December 2010

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