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Strategic Default

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The tendency to default when you are underwater even if you have the ability to pay the mortgage is known as strategic default. In this paper, I would first outline the legal and ethical constraints associated with such defaults and then discuss its implications on the lender, the borrower, and the society as a whole.In recent years many states in the U.S. have witnessed a dramatic fall in home prices. This has encouraged homeowners in these states to simply walk away from their mortgages not out of an inability to pay the mortgages, but because strategic default seems the best available option financially. In order to understand the reasons behind walking away better consider the example of a man who bought a house on credit for $300,000 in a year when the home prices were expected to rise. Suppose now that two years later the homeowner still owes $250,000 but the home prices have taken a serious downward plunge resulting in him owing more than what his house is worth of. Given such an eventuality, it makes much sense, economically, for the homeowner to completely stop making mortgage payments and invest the money saved elsewhere. In fact, defaulting on the mortgage payments seems to be the only option for the homeowners if he were to make his decision to default on a purelyly financial basis.Yet, it can be seen that in actuality, a great number of underwater homeowners carry on paying off their mortgage debts. This non-exercising of strategic default option may be as a result of two reasons: (1) state regulations that allow banks and lenders to pursue legal claims on borrower’s other assets, and (2) shame and fear associated with joining an exclusive club of defaulters that may have made the homeowners reluctant to default.It is important to note that the activity of strategic default is perfectly legal in U.S. There is no law as such that disallows it or deems it punishable. States like Florida and Nevada, however, allow lenders and banks to pursue legal claims against the defaulters either themselves or through some collection agency or firm, making it costly for the homeowners to default.