Should You Consider a 'Strategic Default' on Your Mortgage?
That conclusion is backed by a study of trends data by TransUnion released in January, which found people were maintaining car payments as their first priority, credit cards as second and mortgages last. The national average for 60-day delinquent auto loans was 0.81% for the third quarter of 2009. For credit cards, the national 90-day delinquency average wasjust a bit higher at 1.1%. But for mortgages, the national 60-day delinquency rate wassix times higher at 6.25%.
4.5 Million Underwater Homeowners
So, how many people have crossed that critical threshold where their home falls below 75% of the amount owned on the mortgage? First American reports that by third-quarter 2009 an estimated 4.5 million homeowners reached that point. The next report on negative equity is due out in mid-February. If prices continue to fall in the hardest-hit areas of the country, that number could top 5 million by the middle of 2010.
First American estimates that it would cost about $745 billion, slightly more than the TARP bailout of the banks, to restore all underwater borrowers. Can the government afford to even think about that? Probably not.
Who is actually responsible? Jon Maddux, CEO of website You Walk Away, puts most of the onus on the banks because he says lenders made bad loans. "Those loans created a massive demand for housing because all of a sudden everyone could have the American dream." He strongly believes that lenders are the "root of the problem" because they created the exotic mortgages that led up to this disaster.
Short Sales Not Easy
He agrees that borrowers made mistakes, too, but the "lenders did it thousands and thousands of times, and made billions of dollars" doing it.
For many in the hardest hit areas, working out a short sale is frequently not an option when the home value is so low that a buyer starts considering walking away. That's because the banks are often not willing to accept a low enough offer. For example, in Central Florida, where I live, real estate agents have told me they stopped even showing short-sale homes because they can't get the banks to agree to the offers and it's a waste of their time.
Stricter guidelines from the Treasury Department may get the banks to make a faster decision and put short sales back on the table as an option. Always check with your bank to discuss your options before thinking about a short sale or walking away. Some banks, especially a smaller community bank or a credit union, may be willing to work out a deal. In fact, some banks have even been willing to negotiate a reduction in mortgage principal, so it never hurts to ask as you develop your strategy.
Just a Business Decision?
Today, Maddux helps thousands of people "strategically walk away" from their loans. While many people may think a borrower has a moral obligation to pay the mortgage even if the home is $100,000 or more underwater, Maddux disagrees. He says if the mortgage were a moral obligation, that would be stated in the contract. He sees mortgages simply as a business deal, and the decision to walk away as a business decision.
Maddux, who first worked in real estate finance for 12 years, saw the need to help financially distressed homeowners in 2007. He partnered with an attorney and developed his program and his You Walk Away website. Visitors can use the site to consider four options: Walk Away, Strategic Default, Short Sale and Stay. The goal is to help people make the decision that's best for them.
People who are stuck in a home that doesn't have a chance of regaining its value in 10, 20 or maybe more years, get guidance on how to strategically default, but the site does advise people to work with an attorney in their home state. Each state has different laws that can make strategic default easier or more difficult.
Credit Scores Can Recover
Essentially when people strategically default, they stop paying their mortgage and instead put all their cash toward paying down other debt, such as car loans and credit cards. Since in many states foreclosures take 12 to 16 months, this gives people a significant amount of cash to pay off their other debts.
Yes, it's true the borrower's credit score will be harmed initially: Maddox has found that people he's worked with lose 100 to 125 points on their score. But as long as they pay all their other bills on time and start to decrease all other debt, he finds that within a year the credit score can regain 80 to 90 points. And it will be a lot better two years after a default. A foreclosure will stay on your credit report for seven years, but as it ages, it has less impact on the score.
Maddox has worked with about 5,000 people, and he says none has had trouble getting a rental after a foreclosure. In fact, he says several landlords have told him they find that people who owned a home know how to take care of property and tend to be better tenants. As apartment vacancy rates rise around the country, landlords will be even more willing to ease any credit restrictions that may have been in place previously.
There Are Many Risks
So what are the risks? You do face the possibility that a bank will try to collect any shortfall on the amount due on your mortgage. But if you work with an attorney, you may be able to minimize the likelihood of being chased for the money.
Prior to the recent tax law change, you risked having to pay taxes on any debt that a bank forgives, but that provision has been waived until 2012. However, some states still expect you to pay taxes on any forgiven debt after a short sale or foreclosure, so be sure to check with a tax adviser to find out the laws in your state.
The big question for many will be: Can I ever buy a home again? Surprisingly, yes. Some financial institutions even specialize in "mortgage repair" loans. For example, in California, Golden 1 Credit Union's Mortgage Repair Loan is targeted to people who have been been in a foreclosure in the last six to 18 months. It advertises that it'll will help you buy a home sooner than you expect.
If you've defaulted on a loan and would like to take advantage of some great foreclosure deals out there, look for similar mortgage repair programs in your state. Also, now that millions of people have defaulted on their mortgages, it's likely that when the economy recovers and banks are ready to start lending again, the stigma of a foreclosure stemming from the housing bubble will likely fade. But in today's economy, most banks won't agree to lend to someone who recently foreclosed.
While I wouldn't advise anyone to strategically default, it is an option you may want to consider if you're stuck in a home with a huge loss that you don't expect to ever recover. This can be especially helpful in these tough times if you live in a area where there are no jobs and you need to relocate in order to work again.