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Personal Debt Issues

Paying credit cards on time, letting the mortgage go, common among struggling households

by Broderick Perkins

(10/21/2011) Erate Exclusive - Reacting, in part, to lost home equity and forecasts of home price declines yet to come, a growing number of homeowners may see more value in holding onto their credit cards than their homes.

More Americans are paying their credit card bills on time, as more homeowners are letting mortgage payments lapse 60 or more days in arrears, according to research by Experian, a financial information services company.

Nationally, from 2007 to 2011, the number of credit card payments that are 60 days or more overdue declined by 20 percent, the study found. In contrast, 25 percent more consumers are paying their mortgages 60 days late, according to Experian.

In 30 of the nation's largest metropolitan areas, the percentage of late credit card payments decreased significantly. The percentage of missed mortgage payments (considered to be payments 60 or more days overdue), rose dramatically in 26 regions in the study, and improved in just four.

According to another report, keeping credit card accounts current while letting mortgage payments fall behind, may be a well-planned, though questionable, strategy for certain homeowners preparing for credit life after foreclosure.

Selling the farm

The save-the-credit-card-damn-the-home behavior is common among those who engage in what's called a "strategic default" -- purposely stopping mortgage payments to induce foreclosure or a bail out. Many mortgage rescue programs won't help those who are current on their mortgage, even if they are "underwater" -- paying for a mortgage with a balance that's larger than the home is worth.

Compared to other defaulters, strategic defaulters have not been in their homes very long. To those short-timers, a strategic default may be a no-brainer.

If they purchased their home at the height of the boom and suffered a big value hit, they know they may not recover to the full purchase price of hour home for years, if ever. Since they've paid into their investment for only a few years, they have a smaller stake to lose than long-timers.

Without the burden of a mortgage payment defaulting homeowners have time to stash away perhaps tens of thousands of dollars before the lender finally forecloses. Later, a cheaper rental will cut their housing costs and build in more savings. However, the booming rental market could throw a wrench into their plans.

Keeping plastic

"Predicting Strategic Default," by major credit scoring system architect FICO (Fair Isaac Corp.), found that strategic defaulters aren't true deadbeats because they tend to use credit card credit wisely and keep their accounts current.

• While more than 35 percent of non-strategic defaulters maxed out their credit cards, fewer than 10 percent of strategic defaulters did likewise. Holding onto existing credit cards, with unused credit to fall back on, could come in handy after a foreclosure.

• The study also found strategic defaulters proactively shopping for new credit card lines before they stop paying their mortgage. In the days of waning equity and fears of job loss, some homeowners used the same strategy to tap home equity before it disappeared or they were out of work. Stocking up on new credit before defaulting acknowledges credit will be tough to come by after default.

• Also, those who walk away from their homes and into foreclosure are able to make calculated credit moves because they have higher credit scores. Most strategic defaulters have credit scores above 620. Defaulters with a credit score of 700 or more are more than twice as likely to be strategic defaulters, Experian found.

The higher the credit score before default, the higher the score will be after the 150-plus possible negative credit score hit that comes with foreclosure. For some, that could put access to credit within reach, after just a few years or sooner.

The FICO report wasn't designed to serve as a blueprint for strategic defaulters. Any default is risky business for years to come.

However, the FICO report does indicate, in part, why on-time credit card payments are improving and on-time mortgage payments aren't.

"The era of the strategic default is likely to be a phenomenon coming to an end after 2012, when the window created by the Mortgage Debt Relief Act of 2007 will be closed, whereby many taxpayers have been permitted to exclude from income (by receipt of a 1099) the debt reduced and forgiven by a lender in connection with a mortgage on a primary residence," said Nancy Osborne, Chief Operating Officer of Erate.com, a Santa Clara, CA-based financial information publisher and interest rate tracker.

 

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