You keep your outstanding credit card balances low and stay current on your bills. Your savvy debt management has earned you an above-average credit score. And you’re proud of it. Those are just the factors that may flag you as a high risk for defaulting on your mortgage! What gives?
FICO (NYSE:FICO), the Minneapolis-based credit-scoring and analytics company (formerly Fair Isaac), has produced a new screening tool to help mortgage lenders identify homeowners who pose the greatest risk of “strategic default” or choosing to walk away from an underwater mortgage.
In the aftermath of the financial meltdown, economists and politicians are debating what the “new normal” is in terms of full employment and economic recovery. Now, the very meaning of risk is being redefined in unexpected ways as well.
“As a group, strategic defaulters tend to be more savvy managers of their credit than the general population, with higher FICO Scores, lower revolving balances, fewer instances of exceeding limits on their credit cards and lower retail credit card usage,” FICO said in a prepared release. “This indicates that strategic defaulters display a different type of credit behavior than distressed consumers who miss payments.”
While most defaults occur because a borrower cannot afford to keep up with mortgage payments, “this largely new type of consumer behavior reflects how deeply the financial crisis has affected consumer attitudes” towards debt and default, FICO said. The company cited a study from the University of Chicago Booth School of Business which reported that 35 percent of mortgage defaults in September 2010 were strategic defaults, up from 26 percent in March 2009.
The company announced yesterday that its tool can identify those most likely to choose a strategic default. Based on their research, two thirds of strategic defaults occur in the 20 percent of borrowers they identify as at highest risk of “committing strategic default” and three fourths occur in the top 30 percent.
For borrowers with underwater mortgages the risk factors FICO identified include:
- Good credit history — better FICO scores.
- Lower credit usage, less over limit on credit cards.
- Lower retail balances.
- Shorter length of time in home (less attached).
- More open credit in past six months.
The company also said that borrowers who fit this profile and fall more than 90 days delinquent are “irretrievable” and urged lenders to identify and work with “at risk” borrowers who might even be current on their mortgage payments.
Some lenders are developing dedicated teams to reach out to at-risk borrowers, FICO said in a report outlining best practices among some lenders. Those teams set out to create a relationship with the borrower and engage in “pragmatic rational discussion, working through alternatives and trade-offs.” The alternatives may include a short sale or signing the property over to the bank, known as a “mortgage in lieu of default.”
Borrowers who opt for a strategic default can see their credit score hit by 150 points, FICO said, which could increase their cost for insurance, other credit lines as well as the ability to rent an apartment or purchase another home.
Continued high rates of strategic defaults hold a larger risk for the economy as a whole, FICO said, by “putting just-now-thawing credit markets back in the deep freeze,” which would affect consumer confidence, spending and hiring, precipitating “a downward economic spiral.”