Fannie Mae Isn't Amused by Strategic Defaulters

Underwater homeowners now have a very good reason not to walk away from their homes. Government-sponsored entity Fannie Mae has strengthened its effort to curb strategic defaults. It will crack down on borrowers who enter foreclosure by choice, instead of by necessity. It's doing so in order to encourage borrowers to work with servicers to modify a mortgage, which would benefit its portfolio and the housing market.

The Wall Street Journal reports on its tactics:

Fannie Mae (FNM) said it won't back new mortgage loans for seven years for homeowners who walk away from their mortgages although they were able to pay or did not seek a workout in good faith with their lender.

Borrowers who have extenuating circumstances may be eligible for a new loan in as little as two years, the mortgage giant added.

And that's not all:

Fannie Mae said it also will sue borrowers who strategically default on their loans to recoup the outstanding mortgage debt in jurisdictions that allow for deficiency judgments.

Considering that Fannie Mae is such a major purchaser and insurer of mortgages in the U.S., a seven-year ban from its backing your loan is significant. Not many banks will be crazy about providing loans to people who are shunned by Fannie, so this ruling would virtually ensure that these individuals don't buy another home during this period of time, unless it's done at a very high interest rate that a bank feels makes the mortgage's risk palatable.

It's curious that Fannie expects to be able to easily differentiate between defaults resulting from extenuating circumstances and a simple desire not to pay, however. This won't be an easy task. What if you obtained a modification "in good faith" but then purposely re-default? Do you need to show proof of unemployment or other hardship? If differentiating between strategic defaulters and truly distressed borrowers was a cinch, then laws would more easily be able to distinguish between the two groups. They generally don't.

Finally, it's probably ultimate good that Fannie plans to go after strategic defaulters for outstanding debt. First, this obviously benefits taxpayers. Anyone who rents or responsibly pays their mortgage on-time each month shouldn't be subsidizing people from walking away from a home that they can pay for if they choose. Second, as mentioned here yesterday, the housing market is better off with fewer strategic defaults. If all underwater homeowners just handed in their keys, housing prices would decline endlessly.

For that reason it's good that Fannie is attempting to stop the bleeding. These policies provide a staunch, but unfortunately, probably only a small one. Seven years isn't forever, and many states won't allow Fannie to go after defaulted borrowers. But then, at least the agency is making an effort to improve the situation.