Is a Strategic Mortgage Default Really So Strategic?

Is a Strategic Mortgage Default Really So Strategic?

It was not too long ago when strategic defaults were a viable financial solution for troubled mortgage borrowers. But with banks aggressively pursuing strategic defaulters now, you may want to think twice before going through with this decision.

Among many homeowners who have strategically defaulted on their home mortgage and simply walked away from their financial responsibility, there has been a feeling of calmness as they feel that they have simply rid themselves of the problem. Unfortunately, as many of these strategic defaulters are realizing, that sense that they have felt was a false sense of calm.

When a person walks away from their mortgage, the bank or lender is forced to sell the home in an effort to recoup as much money as possible. But with the housing market the way it is and with the eagerness of the banks to unload these properties, the homes are selling for much less than what is owed on them. In order to make up the deficiency, banks are increasingly obtaining deficiency judgments against the strategic defaulters.  The banks then sell these judgments to debt collectors who then aggressively going after these homeowners.

Joseph Reilly of Florida found this out the hard way. He lost his vacation home last year because he stopped paying on the mortgage after losing his job. For many months, he thought the situation was over. But he received a phone call just a few months ago informing him that there was a judgment against him for nearly $193,000, which was the difference between what his vacation home actually sold for and the amount that was owed on it when he defaulted.

There are 41 states that allow banks and lenders to sue mortgage borrowers for deficiencies if they decide to walk away from their payments. While banks had been lenient on defaulting homeowners in the early years of the housing crisis, many banks have decided to exercise their rights to get a personal judgment in order to try to bring in more money that is owed to them, which is quite often $100,000 or more on each foreclosed home that they sell.

While banks are stepping up their efforts to recoup money from borrowers who have walked away, it is still a small number of cases where they sue for their shortfalls. The majority of cases in which they sue for deficiencies occur when they perceive that the borrower was a strategic defaulter and simply chose to stop paying their monthly mortgage payments even though they could still afford to do so.

Even when banks sell these debts to debt collectors, there isn’t much money to be made by the banks. It is believed that the judgments only sell for about two cents for every dollar - which is a lot less than the seven cents on the dollar that debt collectors typically get for credit card debts.  For debt collectors, however, the business may be more compelling.  Most of the states that allow these deficiency judgments allow collectors up to 20 years to collect on the debt and with an interest rate that is ordinarily allowed to be as high as 8 percent interest rate, the debtors could owe a lot more after just a few years.

If you have been considering doing a strategic default as a way to save money or start over, be aware that banks are being more aggressive than they have been in recent years. Depending on the state you live in and your particular circumstances, you  may still be on the hook for the difference between how much you owe and what the bank actually sells the house for after you default on the loan.

Image: Image courtesy of Stuart Miles at FreeDigitalPhotos.net

Reviews

  • formerly_underwater

    October 27, 2011

    This article is quite misleading. Laws affecting tax and deficiency judgement matters vary substantially by state and the circumstances of the mortgage. Many people can walk away with their only blemish being a hit to their credit score.

    I made the mistake of purchasing my first home in 2005 in California. In 2009, I decided to throw in the towel after requesting a loan modification and being told none would be granted since I was current on my mortgage. I stopped payments, listed the home for sale, and successfully negotiated a short sale with the lenders; part of that negotiated agreement was that I would owe nothing after the sale. In my case, I had a strong negotiating position as I was ready to let the home go to foreclosure, and our debts were non-recourse in the event of foreclosure. When all was said and done, I had erased $200,000 of debt, tax-free.

    Now a year after the sale closed, I can confidently look back and say that defaulting and short selling the home was the best financial move I ever made. I consulted two attorneys as well as a CPA before making the first move to ensure that I was not liable for any deficiency in the event of foreclosure (or should the short sale complete as planned). My FICO score was 800+ and now a year later is 680 and improving. I have had no problems obtaining or continuing to use credit cards (which I've always paid in full each month), and carry no other debts.

    The money I've saved through this whole ordeal is now more than enough for a 20% down payment on another house. When the market bottoms, I'll be ready to purchase another home and be in a position to pay it off in a reasonable amount of time.

  • florida_owner

    October 11, 2011

    Frustrating to many homeowners. You get raked across the coals as a first time homebuyer trying to get into a house before you get priced out of the market. You get roped into a mortgage twice the quoted price at the closing table, with the mortgage broker stating the plan is to refinance in 4-6 months. The financial system has set this up so that no one cares how mortgage brokers, real estate agents, or even the real estate lawyers behave. When the best business decision becomes walk away since you've been screwed, the financial system then says, nope sorry. We're going to rape you for 200 grand if you try that, taking every penny you've ever worked for.

    For many of us, the american dream isn't dying, it's dead.

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