A strategic default is not making payments on a loan on purpose, as opposed to wanting to pay the debt but not being able to. Although both practices have the same result -- not paying back the loan -- a strategic default is more than just semantics. Strategic default is a planned strategy some residential and commercial real estate investors use when they're in a situation that makes it more favorable to default on their mortgage than pay it.
When to consider using strategic default
What usually prompts investors to choose a strategic default strategy is if they owe more on the property than what it's worth, a scenario known as being underwater on the loan. When that happens, many investors choose to stop making payments and let a foreclosure happen.
Other terms for strategic defaults are "walking away," "strategic foreclosure," or "voluntary foreclosure." When borrowers choose a strategic default, they've made the decision to use their cash in better ways than continuing paying toward what appears to be a bad investment.
If an investor is underwater on a loan and having financial difficulties as well, the decision to strategically default becomes a bit easier.
Not all underwater investors default
Not all investors who find themselves underwater on a loan choose strategic default. Some continue to pay the loan, confident the property will be worth more in the future. What currently appears to be a bad investment could prove to be a good one after enough time goes by to let the investment appreciate. Plus, by not defaulting, the investor keeps their good credit, allowing them to make further investments if they like.
What lenders think of this
Banks and other lenders don't like strategic defaults, and they have another name for this practice. They call the borrowers "walkaways" and the act of what they're doing "jingle mail," a reference to the borrower mailing the lender keys to the property instead of the mortgage payment.
The coronavirus caused corporate defaults
Because of financial fallout from the coronavirus pandemic, global corporate defaults reached an 11-year high, and the United States had the most: 146 corporate defaults in 2020. Defaults were highest in the oil and gas industry, with homebuilders and real estate companies in the middle of the pack.
COVID-19-related trouble has also caused investors in the hotel and retail sectors of commercial real estate to stop making payments on their loans. The reasoning is largely due to "bleak prospects for extensions or refinancings when loans come due through next year ," according to a report from Trepp, a provider of data for investment management companies. Multifamily, while not hit as hard as hotels and retail, is also seeing a higher share of defaults.