Estimates have it that up to 31% of all foreclosures in March of this year were the result of “strategic defaults.” A strategic default is when the homeowner just stops paying. He may be ABLE to pay, but he stops. When the lender finally kicks him out of the house, he leaves, and rents somewhere. People are skipping 6-12 months of payments this way, and getting out of a huge load of debt. Is it moral? Is it reasonable? Is it a good idea? The question of “moral” is not answerable. The Federal Government has put you and your children (and possibly grandchildren) on the hook for most of these loans in some way or other. Since your kids will pay anyway…
However, that’s not the only consideration. The fact that the bankers have your money, and your kids will pay anyway, is a fixed and determined thing. The two questions that matter to you are:
- Is this reasonable in terms of what it will do for you?
- Is this a good idea in terms of the potential for future problems for you?
- Here’s a link to A Recent NY Times article on strategic defaults: http://www.nytimes.com/2010/06/01/business/01nopay.html?pagewanted=1
- Also read the following on “deficiency judgments:” http://www.maldonadomarkham.com/california-foreclosure-law.htm (note this applies ONLY in California!!)
Here’s the problem with “strategic defaults”: you may have future costs and a deficiency judgment to deal with. When a lender takes a property back in foreclosure, unless it is a purchase money loan (the loan you used to buy the place you live in, NOT a refinance or loan on an investment property), he can choose a judicial foreclosure, which permits him to pursue you for the additional amount in the note. In addition, if he’s got a “junior lien” (2nd or 3rd, etc.), he can simply not foreclose and then file a lawsuit to collect on the note. This is actually pretty common among lenders. So there are risks. However, as I recently pointed out to a couple, they have in excess of $200,000 extra in loans on their property (for which their infant son will eventually pay, through the magic of govt loan guarantees); that $200,000 will morph into about $588,000 if the loan adjusts as the lender has forecast. So these folks will pay an EXTRA half-million dollars for their little condo. Not good. A default will (for the mere price of having no credit for a few years) earn/save them almost $600,000. These folks are, in fact, doing a short sale, rather than a strategic default, even though their particular loan is exempt from a deficiency judgment (they used the loans to buy the house, called “purchase money loans, AND they lived in it”).
So what should you do?
I recommend a short sale, for the following reasons (other than the obvious one that if you do that, I get to make some money. This is apart from that.)
- A short sale impacts your credit less. A “strategic default” can keep you out of the housing market for much longer (7-8 years), while a short sale typically allows you to purchase in 2 years. This is certainly preferable to terrible credit as far as the eye can see. It is unknown how car dealers, credit card companies and the like will treat strategic defaults, but it is likely they will follow the lead of the real estate lenders.
- You can generally stay in the property while the short sale is going on. You need not make payments (in fact, it’s to your advantage not to do so, since as long as you are making payments, the lender typically is deaf to your pleas for relief. Please note that I’m not ADVISING this course of action (nonpayment). I am merely telling you what our experience has found to work in most cases. You do need to know that once you stop paying, your fate is pretty much determined. You will be moving at some time. Short sale time frames typically exceed foreclosure time frames by a fair margin.
- A short sale effort is a good defense against a lender who decides to pursue an additional judgment against you in judicial foreclosure, or who decides to pursue your failure to pay a note that was never foreclosed (“I tried, your Honor!”. Will it work? Depends on the judge, and the city.
- If you are dealing with a junior lender who wants to sue you, and there is no equity in the property, you can may be able to get that loan stripped in a Chapter 13 bankruptcy (consult your attorney!). This may be necessary to do in consultation with your real estate broker AND your attorney; the chapter 13 bankruptcy strategy needs to be pursued at the proper time and in the proper way.
- A short sale is actually good for the lender. Why? because it will keep the property in better condition. I have been in many foreclosed houses, and in many short sale houses. Without exception, the short sale homes were in better shape, and worth more to the buyer, than the foreclosed or bank-owned homes.
- A short sale leaves you with some dignity. You did your best to “do the right thing.” You could not pay, and so you took the most honorable way out. You attempted to sell for as much value as you could.
- Most loan modifications are NOT WORKING. When you apply to modify your loan, the lender’s goal is to get as much money out of you as he can, because he thinks you will fail (many do). So he is not making a “good faith effort” to help you, and he is NOT YOUR FRIEND. A terrible example I read recently indicated that the HAFA program (touted by the President as the next best thing for our economy) in April managed to modify 171 loans. Since there are MILLIONS of loans delinquent, this program is a terrible failure. See: http://mandelman.ml-implode.com/2010/05/fha-hamp-helped-171-homeowners-nationwide-in-april/
You should also be aware that short sales have a varying success rate. Sometimes the lenders themselves do not make a good faith effort to recover as much of their own equity as they can. Sometimes buyers get discouraged, and walk away, because the process can be lengthy. The reasons are many , and beyond the scope of this article, but you do need to know that a short sale may not work. However, if it doesn’t, you will have lived in the property for an extra 6-18 months, rent-free, which will surely help you if you have financial issues.
Specific questions? Call me. I will probably be able to help you. If you need to list your short sale property, please call when you first go delinquent, or when you receive your first foreclosure notice.
