FICO Releases Strategic Default Predicting Software

One of the major distinguishing factors between a strategic default and any other default on a mortgage is that a strategic default is a deliberate business decision. The homeowner has the ability to make mortgage payments but simply decides not to – usually because the value of the property is less than the money still owed on the property. Traditionally, lenders have used the degree of home value depreciation to try to predict strategic defaults, but FICO Labs, an analytics and decision management technology provider associated with FICO, has released new software and analysis strategies that can “identify borrowers who are over 100 times more likely to default strategically than others”[1].

Researchers have found that home value and principal amount do play a role in strategic defaults, but that there are some other distinct character traits that identify likely candidates to make this decision. Strategic defaulters tend to have “higher FICO scores, lower revolving valances, fewer instances of exceeding the limits on credit cards and lower retail credit card usage.” In fact, their behaviors are nearly polar opposite of those of distressed defaulters. Strategic defaulters default “because they believe it is in their best financial interest, and because they believe the consequences will be minimal,” says FICO Labs head and FICO chief analytics officers Andrew Jennings. Furthermore, they plan ahead for the hit they will take when they default, he adds, opening new credit cards and arranging for housing before they “do the math and walk”[2].

The team of researchers from the European University Institute, Northwestern University and the University of Chicago believes that 35 percent of defaults in September of 2010 may have been strategic. However, these numbers are difficult to pin down because strategic defaulters have “the incentive to disguise themselves as people who cannot afford to pay” in order to avoid aggressive recouping action on the part of lenders. Another study by Morgan Stanley also notes that despite the careful planning aspect of a strategic default, the decision is also largely influenced by emotion. People with new, large balances on their mortgages are more likely to default, but people who believe that doing so is immoral are less likely to. Anger at a financial institution or situation makes a strategic default far more likely, as does acquaintance with another borrower who strategically defaulted with apparent “success.”

Many people find it very easy to empathize with strategic defaulters because they themselves are so frustrated by the existing housing situation. Do you think a strategic default can be justified? Do you know anyone who has benefitted from doing it?

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