In Down Real-Estate Market, Homeowners Are Deciding to Abandon Their Loan Obligations Even if They Can Afford the Payments

PHOENIX — Should I stay or should I go? That is the question more Americans are asking as the housing market continues to drag.

In good times, it would have been unthinkable to stop paying the mortgage. But for Derek Figg, a 30-year-old software engineer, it now seems like the best option.

Mr. Figg felt trapped in a home he bought two years ago in the Phoenix suburb of Tempe for $340,000. He still owes about $318,000 but figures the home’s value has dropped to $230,000 or less. After agonizing over the pros and cons, he decided recently to stop making loan payments, even though he can afford them. Mr. Figg plans to rent an apartment nearby, saving about $700 a month.

A growing number of people in Arizona, California, Florida and Nevada, where home prices have plunged, are considering what is known as a “strategic default,” walking away from their mortgages not out of necessity but because they believe it is in their best financial interests.

A standard mortgage-loan document reads, “I promise to pay” the amount borrowed plus interest, and some people say that promise should remain good even if it is no longer convenient.

George Brenkert, a professor of business ethics at Georgetown University, says borrowers who can pay — and weren’t deceived by the lender about the nature of the loan — have a moral responsibility to keep paying. It would be disastrous for the economy if Americans concluded they were free to walk away from such commitments, he says.

Developments: Is Walking Away FromYour Mortgage Immoral?

Walking away isn’t risk-free. A foreclosure stays on a consumer’s credit record for seven years and can send a credit score (based on a scale of 300 to 850) plunging by as much as 160 points, according to Fair Isaac Corp., which provides tools for analyzing credit records. A lower credit score means auto and other loans are likely to come with much higher interest rates, and credit card issuers may charge more interest or refuse to issue a card.

In addition, many states give lenders varying degrees of scope to seize bank deposits, cars or other assets of people who default on mortgages.

Even so, in neighborhoods with high concentrations of foreclosures, “it’s going to be really difficult to prevent a cascade effect” as one strategic default emboldens others to take that drastic step, says Paola Sapienza, a professor of finance at Northwestern University. A study by researchers at Northwestern and the University of Chicago found that as many as one in four defaults may be strategic.

Driving this phenomenon is the rising number of households that are deeply “under water,” owing much more than the current value of their homes. First American CoreLogic, a real-estate information company, estimates that 5.3 million U.S. households have mortgage balances at least 20% higher than their homes’ value, and 2.2 million of those households are at least 50% under water. The problem is concentrated in Arizona, California, Florida, Michigan and Nevada.

Josh Cotner, who owns an insurance agency, says his mortgage balance is about $100,000 more than the market value of his home in Gilbert, Ariz. Mr. Cotner could rent a bigger home nearby for $600 a month, far below the $1,655 he now pays on his mortgage, home insurance and property tax. He says he recently stopped making mortgage payments because his lender wouldn’t help him reduce the principal on his loan under a federal program in which he believes he is qualified to participate. Given the sometimes lengthy legal process of foreclosure, he may be able to stay in the home for at least another nine months without making any payments.

Banks warn they may get tough with strategic defaulters by pursuing legal claims on a borrower’s other assets. “We will try to reduce people’s payments if they have a hardship,” says Thomas Kelly, a spokesman for J.P. Morgan Chase & Co. “But we have a financial responsibility to get people to pay what they owe if they can afford it.”

Steven Olson, a loan officer and roof installer in Roseville, Minn., defaulted in 2007 on a plot of land in Florida he had bought as an investment. “I thought I could move on with my life,” he says. But the lender, RBC Bank, a subsidiary of Royal Bank of Canada, sued him, seeking to make him pay more than $400,000 to the bank to cover its losses on the loan. Mr. Olson has hired a Florida lawyer, Roy Oppenheim, to resist the claim. An RBC spokesman declined to comment.

The Burning Questions