Strategic Mortgage Default

The value of property is hopelessly underwater, and will take 10+ years to reach the loan value. Should I allow a default?

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Underwater
Bill's Answer: Answered by Mark Cappel

What you are really asking about is called strategic mortgage default, where a homeowner voluntarily walks away a mortgage because the balance of the mortgage(s) is greater than the fair market value of the home.

Two schools of thought have emerged regarding the ethics or morality of strategic mortgage default. Former Treasury Secretary Henry M. Paulson Jr. is quoted in The New York Times saying that "any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator -- and one who is not honoring his obligation."

On the other hand, Brent T. White, a University of Arizona law professor and author of Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis argues that the deleterious effects of foreclosure are less than people expect, and that morals and ethics should not enter into an economic decision. After all, banks use economics and not emotion when making loans, and banks are not averse to breaking leases for office space when it is to their benefit. Therefore, I will leave the ethics question up to you to decide.

If a modified mortgage will cause you financial distress, then there is no moral or ethical issue to ponder -- you must walk away from the deal and the property. If the deal is bad, consider a short sale or deed in lieu or foreclosure.

You did not mention foreclosure, but would be remiss if I did not point out the Bills.com resources Judicial Foreclosure, Foreclosure Advice, and Stop Foreclosure as sources to learn more about foreclosure.

Recommendation

You mentioned economic reasons to allow a strategic default, which are compelling. However, you do not mention intangible reasons to stay in the property. For example, if you have minor children who attend a great neighborhood school, then that is a benefit to staying. Also, if the property is your dream house, in a great location with neighbors who a picture-perfect, then your chances of recreating that neighborhood synchronicity are low. Living in a great house that you love disfavors strategic default.

On the other hand, if the neighborhood is in general decline, you have no attachment to the area, and your children (if any) would be happier elsewhere, then the intangibles are in favor of a strategic default.

Before you settle on a strategic default, be sure to educate yourself on the Home Affordable Foreclosure Alternatives Program (HAFA), which is a federal program that defines standards for short sales.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

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Comments (42)


Chuck F.
Atlanta, GA  |  July 03, 2013
I think it is beyond duplicitous for a guy like Paulson to make a moral judgement about a home owner. The fact is that when they bank lent you the money for your home, they were speculating. They made a bet that you would pay them 30 years worth of interest in the first 10 years of the loan, and then continue paying on it for another 20 years. Another bet they made was that your home would not decrease in value. But thanx to big wall street guys like Paulson who made billions on these bets, the market tanked and YOU were left holding the bag. There is no question of morality involved here, and home owners should not be the only ones who bear the losses of a bad bet.
Keith J.
Westfield, NJ  |  October 04, 2012
Bill, I am considering a Strategic Default. The property is in my name and was my primary residence until I remarried in the last 6 months. I currently have the house listed for $100K less than the mortgage balance. My wife owns her home which she received as part of a divorce settlement and is afraid that my mortgage company would come after her and force the sale of her home where we live now. She is the sole owner of her house and I am the sole owner of mine. Is there a risk to her?
Bills.com
October 04, 2012
You indicated you reside in New Jersey, which is not a community property state. In common law states like New Jersey, spouses are generally not responsible for each others debts. (Exceptions apply for medical and related debts in some states.) However, I am not a New Jersey lawyer, and my exposure to New Jersey law is limited, so I recommend you consult with a New Jersey lawyer who has bankruptcy experience for a more authoritative answer. I am not suggesting bankruptcy is the answer to your issue here, but a New Jersey bankruptcy lawyer will know the debt-related laws backwards and forwards and will help you understand your options for resolving the $100,000 deficiency balance should you decide to strategically default.
Georgia G.
Mableton, GA  |  July 13, 2012
Hi Bill, We bought a house in Atlanta, Georgia in '05 for $575,000. We had to move to another state because of a job over a year ago and have been trying to sell or rent the house since then with no luck. We have 1 mortgage and owe $400,000 or so on it. The house realistically is probably worth $375,000 or a little less now. We can barely afford paying the mortgage and the rent of our current place now, frequently having to dip into savings. That is just painful! We do have some assets, and do not want to jeopardize those. What would you recommend doing? I am getting panicy, as the real estate market in Atlanta does not seem to be recovering at all. Thanks in advance!
Bills.com
July 15, 2012
First, check out if you are eligible for a HARP mortgage refinance. Perhaps a 30 year loan at a lower interest rate will help lower your payment to a more affordable one.

I recommend that you speak with your current lender regarding available foreclosure alternatives, including loan refinance, loan modification and short sales. Check out your budget and cash flow. Explain to the lender your capabilities and your desire to pay off your loan with reasonable payments, based on your financial situation. If you do decide to do a short sale, then you will need to negotiate a settlement for the deficiency balance. If correctly done this will not hurt your credit score.

Also, speak with a local real estate agent to receive realistic rental and sale prices. Perhaps by renting at a real market price you will be able to afford the mortgage payments.
Greg H.
Macomb, MI  |  May 14, 2012
Bill I have 2 rental properties which are both underwater....property one is valued at $30000 and I owe $60000....property 2 is valued at $45000 and I owe $82000. I was considering doing a short sale on both properties but heard that a forclosure would be better since both homes are rentals. I was told that Fannie Mae and Freddie Mac are buying most foreclosed properties and paying off the mortgages to the banks and in such would create no financial obligation to pay back the bank or incur tax consequences. (I have estimated that in a short sale, I would owe approx $15000 in taxes after my write-offs.) The only downfall would be a major hit on the credit report which I could handle since the car I am driving is newer and I have a principal residence. What uis your thinking?
Bills.com
May 14, 2012
I am not aware of a program whereby you would go through a foreclosure on investment property without negative consequences. I suggest that you verify with your lender if such a program really exists. Both a short sale and foreclosure will negatively effect your credit score, although in general a foreclosure is considered more damaging. I recommend speaking to your lender and negotiating a short sale and settlement on the deficiency balance.
Sandy H.
Roselle, IL  |  April 23, 2012
I have a question. My husband and I bought our house in 06 for $340,000 and now it is worth $220,000. We refinanced last year at a really high rate since we are so far under water. We pay 7% interest and in 4 years that interest is going up to 13%. We can just barely afford our mortgage now and we can DEFINITELY now afford our loan in 4 years. Do you recommend getting out now or waiting? My parents have offered to loan us some money so we can refinance but that would just mean sinking in another $100,000 into a house were we already lost $120,000 (not to mention the $30,000 in remodeling expenses). So we would have a mortgage to the bank and my parents hard earned retirement money. I don't see our house going up much more in the future. It already came up to $220,000 and looks to be staying there. Our house is small and we would like to move out if possible. I drive 90 miles a day to work and it costs about $450 a month in gas. My parents are really against foreclosures and I would appreciate some professional advice. It just seems like a poor investment just to "save face"
Bills.com
April 23, 2012
I really dislike the idea of someone pouring their retirement savings into a child's upside down mortgage. I understand the moral argument here, "A contract is a contract. Promises made, promises kept. Home ownership is not speculation," and so on. The facts as you presented them are:
  • The house's value is $220,000 and will probably stay $120,000 underwater for the foreseeable future.
  • The house is too small for your needs
  • The house is too far from your place of work
  • The existing loan will eat you in the coming years
  • You cannot refinance without bringing a huge amount to the table

Your facts make an excellent argument in favor of a strategic default. No one likes strategic default, but the choice of raiding a parent's retirement fund is an even worse idea.

My advice? Talk to a lawyer in your state who has real property experience to learn more about your state's anti-deficiency laws, if any, and your options for handling the deficiency balance.

Tom F.
Providence, RI  |  April 19, 2012
hello Bill, first - thanks for all this valuable info. briefly, officially divorced 1 year ago. Judge decreed all rights/responsibilities of the house to me, although we are both still on BofA mortgage. I am unable to just 'remove' her from the mortgage. My ex and me have both agreed to strategically default on our mortgage as it is hopelessly underwater. There is also a HELOC of about 20K. I am just about to not pay my fist ever missed/late payment in a few weeks. I have also attempted loan mod/HARP, but the bank does not assist willingly with me being up to date on mortgage. I am now committed to 'living off the grid' by this time next year. (Meaning that I will be 'on the road' and probably not in the USA) question 1: I understand in RI BofA can pursue collection and levy against my bank accounts for the HELOC amount. Should i also enter into bankruptcy after foreclosure proceeding begin? question 2; Will BofA continue to pursue collection from my ex, because she is still on the mortgage - even though the judge has decreed she has no obligation to the house? Observation: in for a penny... I had intended to get my credit card balances down to zero before 'leaving'. 2 birds one stone? this way I avoid paying off credit cards myself. I look forward to your thoughts. Thank you in advance. Sincerely, Tom
Bills.com
April 19, 2012
Removing a spouse's name from a joint mortgage is a common question among Bills.com readers.
  1. See the Bills.com anti-deficiency page to learn more about the recourse/non-recourse laws for home loans in your state. Regarding bankruptcy, I do not see if filing it before or after a foreclosure will make a significant difference in terms of your liability. However, I hasten to add I have a tiny window into your situation, and time spent with a bankruptcy lawyer may result in a different conclusion.
  2. Generally speaking, one joint debtor filing bankruptcy does not wipe out the liability of another (there are exceptions to this rule in community property states for spouses in some situations). The divorce decree binds you and your ex-spouse, but is not meaningful to your joint creditors. In other words, a divorce decree does not change your contractual obligations to your lenders.

I cannot say if your home loan lender will forgive any deficiency balance or pursue one or both of you.

Regarding your credit card debt, discuss this with a bankruptcy lawyer.

Shelia B.
Thomasville, NC  |  March 31, 2012
My husband and I have had our house listed with a realtor for two months now and have a few people walk through but had not offers. I am currently living in the house with my children but my husband moved out of state for a better job. The children and I plan to move to where my husband is and we plan to rent for about a year (right now my husband is living with relatives but there is not room for our whole family to move in with them). Our market value is $185,000, we owe $167,000 and we are asking $179,000. My concern is that we may have to take a lower offer to sell our house and after closing cost, we may end up owing money to sell (as much as $10,000). If we didn't have to pay the realtor or closing cost we would be ok to lower the price to just what we owe but we have a 6 month contract with the realtor (until the first of Ausgust). Sadly enought we really can't even afford to be short even the smallest amount going into closing because we need all of our savings just to move the family and get set up in another rental house. We don't want to hurt our chance of getting another mortgage in a year or so but we don't know what our best options are either. Can we get out of our contract with the realtor or should we just continue on until it expires. I know we cannot afford a mortage payment here and a rent payment where we are moving to. Our realtor did ask us if we would be interested in the option of having someone lease our home but I would really just like to know that we are done with it and can concentrate on getting moved in and settled at our new location. I am afraid if we lease our home we will not be able to ask the full amount of our mortgage payment and that would need to be considered when looking at rent options where we relocate to as well. Or we to a point where we should consider deed in lieu of forcloser or maybe a short sale (if the bank will even agree)? My children and I will be moving out of state to be with my husband in the middle of June and we will need to have a place to rent by at lease the first of July. My husband and I just don't know what is the best direction to take at this point. Please point me to the souces that will be the most benefit in my situation. Thank you so much for your time.
Bills.com
April 01, 2012
If you have a contract with the realtor, then your ability to break the contract and the remedies available to the realtor should be specified in the contract. If you walk away from the house, it might be sold for much less than you can get for it if you try to sell it yourself. The deficiency balance (the amount you owe the bank after the sale) might still be collectible, depending on the anti-deficiency laws in your state. In any case a foreclosure will greatly damage your credit. I recommend that you sit down with the realtor and try to work out a program where you can sell the property and pay all your debts.
Mike M.
San Jose, CA  |  March 19, 2012
Hello Bill, I currently live in the 2BR/2BA condo I bought in San Jose, CA, in March 2005 for $415k. I bought it with two loans comprising 80% on the first, and 15% on the second, with the remaining 5% down. Since purchasing the condo in March 2005, I got married in 2008 and we had our first child in 2010. It's now 2012 and several units in my complex have gone to foreclosure or short sale with the ultimate sales price hovering around $230K. That's a 45% loss. Currently, there are 3 units in my complex that are in default and/or foreclosure. We have outgrown this condo and will have a second child in 2013. I have excellent credit and can afford to make my payments. However, we plan to move back to the east coast in approximately 3 years. I've considered a short sale, but figure why should I pay another $13K in realtor commissions on a property I've lost so much value in and in addition to improvements I've made (kitchen, bathroom, etc.). I figure if I walk away, I can begin the process of rebuilding my credit and hopefully have some sort of credit by the time we move in approximately 3 years. Also, if it closes before 2012, I won't have to pay income taxes on the cancelled debt. I just wonder whether a short sale or strategic foreclosure is the way to go. To get back to even, I'd need an 80% increase in market value. Also, I've read from the latest study by Fair Isaac that on a credit score basis, there is minimal difference in your credit score between short sale and foreclosure. Is there a difference in the length of time to recover from each? Thanks for listening and sorry for the long post. It keeps me up late at night.
Bills.com
March 20, 2012
You are not the only one losing sleep. What happens if homeowners who are hopelessly underwater decide that a strategic default is a better choice than living in a property where they will never see it above water? That is why some economists have proposed a write-down of all home loans on underwater properties. The argument is lenders will have to write-down these properties eventually, so we as a nation might as well do it all at once in an orderly fashion. My macro-economic digression does nothing to answer your question, however.

Let us assume your property values will not rebound significantly anytime soon. If we start with that assumption, and you plan to leave the area, one option is to rent the property if your condo association allows rentals. If not, then you face a severe cash-flow situation, as opposed to merely a terrible cash-flow situation if you become a landlord.

Your analysis of the difference between a short sale and a foreclosure is accurate, but completely non-sensical from my perspective. A short sale is a controlled landing, whereas a foreclosure is an uncontrolled crash. If credit scores are predictive statistics, then it is quaint and old-fashioned for Fair Isaac & Co.'s statisticians to equate the two given the state of today's real estate market. In my humble opinion, a short sale should be treated as a positive event that raises a person's credit score. Borrowers should be rewarded for choosing an alternative to foreclosure because that shows fiscal and legal responsibility. Fair Isaac should not punish people who avoid foreclosure.

If you are locked into leaving the area in three years, and there is no prospect for a rapid up-tick in the value of your property soon, you would be wise to bail out now. You and your spouse can spend the next three years rebuilding your credit score(s), and saving all you can for a down-payment.
Andrea M.
Beaumont, CA  |  March 16, 2012
Hi, 5 years ago my husband and I purchased a track home in California. The home was $362,000, and it was our first home. We had saved for a very long time, and we put $70,000 down and got a fixed rate mortgage. The homes were new, and they were ALL serviced by Country Wide. When we all started moving in, it became apparent right away that most (or all) of our neighbors could not really afford the homes. Lawns were not watered, etc. Within 2 years, most of the houses were empty. Many still are. My husband and I have held on for 5 years, and sadly the homes around us are selling for $130,000. We still owe $260,000. We can still afford the mortgage, but we want out. We now have a son, the neighborhood is not great, and we are tired of living in an abandoned community. What options do we have? Thanks!!!
Bills.com
March 17, 2012
My guess is you know your options:
  • Short Sale
  • Strategic Default (discussed above)
  • Stay and hope it gets better

Based on the circumstances you described, none of these options are good. If you short sell your home or allow a strategic default, your credit score will suffer, and you will lose any chance of ever recovering the down payment you put into the house. However, if you stay, it will almost certainly be years before the market values in your area recover. And who knows? Your neighborhood may flourish in the next five years. Or, it may get worse.

My advice? Step back and look at the development with outsider's eyes. Look at the area's economy. Is today the low point for your local economy and the life of the development? If so, then hang on. If, however, you live in an area where jobs have gone elsewhere, and properties in your development will continue to slide in value for the foreseeable future, then get out now before things get worse. Consult with a lawyer who has experience in real property law to understand your rights and potential liability for the deficiency balance.

Cinda H.
Berlin, NH  |  March 05, 2012
I have a house I bought 4 years ago, and I have a leaky roof and chimney that needs to be replaced. I have a 25K estimate and that is only for half the roof. I can afford the mortgage payments but can't get any money to repair the roof because I'm negative equity about 40K. Most banks will only lend about 10K - 15K for a home improvement loan and that payment will put me over my budget especially with soaring energy costs. I'm thinking about walking away since I don't want to live in the area anymore because jobs are scarce. The house has been on the market since last spring and no one has even looked at it and even if I lower the price who is going to buy it knowing they are facing somewhere between 25K and 40K to fix the roof. I have a really good credit score and good income and I'm in my early 50's. I'm thinking of down sizing and cutting my loses. Any suggestions?
Bills.com
March 05, 2012
First, find out if your loan is a recourse or non-recourse loan. If it is a non-recourse loan, you can walk away with only damaged credit and not with personal responsibility for the deficiency balance. Also check out your state's anti-deficiency laws.

If you are liable for any deficiency balance, should you choose to walk away, you should try negotiating a short sale with your lender, attempting to get any deficiency balance forgiven. Other than that, you are facing collection efforts from your lender, the effects of which will be based on your income, assets, and the state collection laws where you live.
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