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?

I was not able to continue making payments on my mortgage and home equity payments due to an income reduction in 2009. I attempted a loan mod, but was told I make too much. I then tried a short sale, but the 2nd mortgage holder would not agree to the amount that the 1st mortgage holder was willing to pay them. I have since gotten a new job. I still cannot make the payments on the home equity, but can afford to pay the 1st mortgage. Also, the 2nd mortgage holder has charged off the loan. I owe $315K on my 1st and $205K on my 2nd, and my home is worth $220K. Is there any benefit to getting my 1st mortgage current? Experts predict it will take at least 10 years to get the home values back to what I owe. Should I just walk away or get current on my 1st mortgage and work out a settlement plan with the 2nd mortgage holder?

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Highlights

  • Two schools of thought have emerged regarding the morality of strategic default.
  • Is it immoral to walk away from a mortgage you can afford?
  • Or, is it just smart economically?

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

41 Comments

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  • KJ
    Oct, 2012
    Keith
    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?
    0 Votes

    • BA
      Oct, 2012
      Bill
      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.
      0 Votes

  • GG
    Jul, 2012
    Georgia
    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!
    0 Votes

    • BA
      Jul, 2012
      Bill
      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.
      0 Votes

  • GH
    May, 2012
    Greg
    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?
    0 Votes

    • BA
      May, 2012
      Bill
      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.
      0 Votes

  • SH
    Apr, 2012
    Sandy
    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"
    0 Votes

    • BA
      Apr, 2012
      Bill
      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.

      0 Votes

  • TF
    Apr, 2012
    tom
    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
    0 Votes

    • BA
      Apr, 2012
      Bill
      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.

      0 Votes