Strategic Defaults in Today’s Market

If your house is worth less than you owe, you are said to be underwater. This is the situation that tends to lead to a short sale of foreclosure, unless the homeowner can afford to continue making payments on the home and wait out the negative equity. By now, the term “underwater” has become commonplace. A related term that is being talked about a lot lately is “strategic default,” or the act of walking away from a home that is underwater but the homeowner can still afford to pay their mortgage. What are the consequences of choosing this route and what about the moral issue of leaving that debt for the banks to deal with?

Bob Stahl explains why some homeowners are choosing a strategic default:

“On July 27, I wrote about the nuts and bolts of a strategic default — including the process and its consequences.Yesterday, I had a long chat about it with my friend Matt Maret, a mortgage banker with Bell Mortgage. It was fascinating to get a mortgage lender’s take on this trend toward ’strategic’ defaults. Matt echoed the real estate attorney’s statement that Arizona’s anti-deficiency laws protect a homeowner’s other assets (besides the home) in the event of a default. But Matt qualified that the anti-deficiency protection, as of September 1, will apply only to primary residences, not to second homes or investment properties. Matt also elaborated on one option I talked a bit about last week — the short sale. He said that the FHA will lend to a person who has a short sale on record (even if it was yesterday) — as long as there are no late payments on the person’s credit (and that person is otherwise qualified, of course).”

The consequences of a strategic default or, as some call it, “just walking away,” really aren’t as bad as some might think. If the homeowner defaults on their primary residence, they can still get an FHA loan for another property in two years, as long as certain criteria are reached. So walking away simply makes sense if you have high payments on a home that may not regain its equity for years to come, if ever. But some say reneging on a contract that you can afford to comply with is a poor business practice. In effect, you have made a promise to the bank to make payments as long as you are able, but have decided it is no longer in your interest to do so, so you stop, leaving the banks to soak up the debt.

lick through to read Bob Stahl’s full post.

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