When Ken Carpenter bought his two-bedroom Florida condominium in 2004, the investment looked like a no-brainer.
The 68-year-old retired General Motors quality engineer, who lives in Michigan, paid a little under $200,000 for the West Palm Beach apartment in a complex with a swimming pool, tennis courts and fitness facilities. His adult daughter, who lived there and had been renting, would move into the unit and pay rent. The apartment would also serve as a vacation property for Carpenter and his wife.
“I knew property values were rising, and I thought if worse came to worse and my daughter had to move out I could sell it and at worst wouldn’t lose anything,” Carpenter says.
Carpenter’s daughter moved to the West Coast in 2007. And while he’s been able to continue renting the apartment, Carpenter is losing $500 a month after paying the mortgage, insurance and condo association maintenance fees. A much bigger pain point is Florida’s collapsed housing market. The condo carries a $153,000 mortgage, but was assessed recently at just $80,000 — putting Carpenter deep underwater on the loan.
Now Carpenter is hoping to sell the condo — at a steep loss — to a third-party company that negotiates with banks to purchase underwater mortgages. But if that fails, he may decide to walk away from the condo, making a so-called “strategic default” on the loan.
Strategic defaults are quite different from defaults and foreclosures that occur when homeowners don’t have sufficient resources to make payments. The decision by homeowners with resources to walk away stems from the steep drop in housing values in some parts of the country — and their judgment that continuing to pay doesn’t make sense.
The decision for Carpenter is a tough one. He has a healthy retirement income of about $6,000 per month from his General Motors pension and Social Security, but finds that with the drag of the mortgage in Florida — plus a smaller mortgage on his Michigan home — he’s barely staying afloat. While his credit score remains high, he can’t save any extra cash for an emergency, and he is also building a credit card balance. “Walking away from this runs against every grain in my body — it’s a contract I signed. But it is slowly dragging me down,” Carpenter says.
Mortgage debt among older American homeowners like Carpenter rose during the years when the housing bubble was inflating — reversing the long-standing trend of declining debt as retirement approached. Some 63 percent of people in their late 50s and early 60s currently carry mortgage and home-equity debt, up from just 49 percent in 1989, according to the Joint Center for Housing Studies at Harvard University.
At the same time, older homeowners are sinking underwater on those mortgages at above-average rates. Last year, up to 22 percent of homeowners age 55 to 64 would have had to bring cash to a closing on the sale of a primary residence, according to the Center for Economic Policy Research, and up to 36 percent of homeowners age 45 to 54 were in the same boat.
That latter figure is much higher than the national average, which currently stands at 21 percent, according to research by IBISWorld.
“Retirees or baby boomers are more likely to strategically default on their underwater mortgages than their younger counterparts, as all of their wealth is less likely to be tied up in real estate assets,” says Robert Andrew, housing analyst with IBISWorld.
The housing market continues to be weighed down by high unemployment rates, foreclosures and tight lending standards. The recently expired federal tax credit for homebuyers provided some support, but IBISWorld expects prices to bottom out until later this year, and then rise only modestly for several years to come.
A big jump in strategic defaults could produce additional shock waves in the market — although walking away can carry a heavy cost — depending on where you live.
The credit scores of defaulters typically plunge, and banks can go after a borrower’s other personal assets in some states — although University of Arizona law professor Brent T. White notes that some states have non-recourse laws that prevent that from occurring.
White has written extensively on the ethical and legal issues surrounding strategic default. Key variables in a decision, he says, include how far underwater the loan has become and the prospects for a real estate recovery in a given market. “People need to consult with an attorney and a financial adviser before making any decision. But I don’t believe guilt and shame are good reasons to stay in a house,” White says.
Fannie Mae announced earlier this summer that strategic defaulters won’t qualify for new Fannie Mae-backed loans for seven years after their foreclosure, and that it will go to court when it can to recoup outstanding loan balances from borrowers.
In my next post, I’ll take a closer look at the debate over the ethical and moral issues surrounding strategic default.