Strategic default

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A strategic default involves defaulting on a promise to pay back a debt for non-financial reasons. Normally people default on a loan because they have lost their income or otherwise find that they are unable to make the agreed upon payments. However, some people who have the means, may go into default because the collateral used to secure the loan is now worth less than what they have yet to pay.

Strategic defaults have been fairly uncommon until recently. One reason is because traditionally higher down payments have been required. Also house values have generally risen in most areas. The oddest thing about strategic default is that they seem to be more of a cultural issue. Many people have taken out loans that they cannot repay in society as a whole seems to be blaming banks more than the individuals. Sometimes they're good reasons to blamed the banks and mortgage brokers–particularly in cases where they outright lied to clients. However in many situations people took out loans that they simply could not afford and should've known better.

This tendency to blame the people making the loans has made some members of society feel that it isn't their fault that their house value went down. Since they can blame it on someone else they feel justified in walking away from the home and simply not making any more payments on it. In the past people haven't wanted to do this because it would hurt their credit, their sense of pride would not allow them to, and they felt a moral obligation to repay the money they borrowed.

An interesting ethical issue. Some people feel that if you have the income to continue to pay your mortgage you should obviously make the payments. Others feel that the banks and mortgage brokers are all acting in their best interest which means individuals should act in their own best interest in order to maximize their finances.

The problem with just assuming that everyone should act in their own self interest is that this is not the foundation upon which our business agreements have typically been built. In the United States we generally expect someone to keep their word. Many business contracts are merely verbal agreements and there is a level of trust that each party will do what they say they will do. Beyond that there is a level of expectancy that both parties will “do what is right”. That involves doing things like not trying to take advantage of the loophole and honoring the intent of an agreement beyond the actual wording.

If we destroy this fundamental part of doing business in America, we will probably see some drastic changes in the way business is conducted. For example, banks that make loans may require a great deal more collateral for someone buying a house because they know that person may walk away from making the payments even if they have the means to continue paying. Banks may also require larger down payments. Some of these things may not be bad changes to the mortgage industry. However if they're being done because the fundamental distrust between business parties in the United States we can expect it to become a lot harder to do business in the future.