FICO launched an analytic advance that substantially improves lenders’ ability to identify borrowers at risk of strategic default on mortgages.
The analytics provider is now consulting with mortgage lenders to offer custom analytic solutions for their mortgage portfolios. This would allow these originators to take preventative action and limit the costly effect of strategic defaults.
A strategic default is when a borrower who has the capacity to make mortgage payments chooses to default, usually because the property value is less than the mortgage’s outstanding principal.
Lenders have traditionally utilized the degree of home price depreciation to predict strategic defaults. However, new FICO Labs research showed that borrowers whose homes have lost the most value are only two times as likely to default as those whose houses have lost the least value. By using custom analytic models, FICO Labs researchers have shown the ability to identify borrowers who are over 100 times more probable to strategically default versus others.
Additionally, FICO Labs researchers have also found that strategic defaulters as a group are usually more savvy managers of their credit compared with 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. This means that strategic defaulters have shown a different type of credit behavior versus distressed consumers who miss payments.
“Mortgage payment patterns have shifted, and some borrowers are intentionally defaulting on their mortgages because they believe it is in their best financial interest, and because they believe the consequences will be minimal,” said Dr. Andrew Jennings, chief analytics officer at FICO and head of FICO Labs. “Before mortgage servicers can work effectively with potential strategic defaulters, they must first be able to identify them. Our new research shows it is possible for servicers to find those at greatest risk of strategic default, both to prevent losses and to prevent borrowers from making a decision that will damage their credit future.”
Experts said that the persisting mortgage sector weakness is driving more strategic defaults. Studies from the University of Chicago Booth School of Business showed that in September 2010, 35% of mortgage defaults were strategic, increasing from 26% in March 2009.
Meanwhile, CoreLogic's March 2011 study showed that the number of residential mortgages with negative equity totaled 11.1 million in 4Q10, or 23.1% of all residential mortgages in the U.S., rising from 22.5% in 3Q10.
The FICO Labs team built strategic default analytics that test the ability to rank-order both current and delinquent borrowers in terms of their likelihood of strategically defaulting on their mortgage. These custom models separated borrowers into high versus low strategic default risk bands. Among current borrowers (i.e., those not delinquent on any loans):
The riskiest borrowers are 110 times more likely to strategically default versus the least risky borrowers. The riskiest 20% of borrowers comprised 67% of those who later committed a strategic default. In short, FICO said that a servicer could reach two-thirds of those who would commit strategic default by focusing on just 20% of its borrowers.
“The ability to spot likely strategic defaulters before delinquency enables servicers to intervene early,” Jennings said. “Strategic defaults are bad for lenders and investors, they’re bad for the homeowners who elect to default, and they’re bad for neighborhoods and cities. Preventing them is in the interests of everyone involved.”
Additional details about the FICO Labs research findings have been published in a new white paper called Predicting Strategic Default.