What is a Strategic Default?

The term Strategic Default is the current buzz word ringing in homeowner's ears. Homeowners considering to strategically default on their mortgage need to carefully consider the pros and cons.

Homeowners should consult with a CPA or attorney regarding any tax liabilities or deficiency issues arising from either the foreclosure or short sale before proceeding. Before a homeowner walks away from their mortgage debt, there are several important factors they need to consider. Homeowners need to make sure that the ramifications of a strategic default far outweigh the costs and benefits of avoiding foreclosure.

Homeowners need to fully understand what a strategic default is. A strategic default is when a homeowner can afford to continue making payments but chooses not to do so. Some homeowners are choosing to not make payments because they owe more than their property is worth. When a homeowner owes more on their property than it is worth, the property is said to be underwater. Homeowners are choosing to walk away from their property when it's underwater because the thought of paying on the loan for years and never recouping their investment doesn't sit well with them.

Homeowners considering a strategic default need to educate themselves on the pertinent laws in their state. Non-Recourse states utilize trust deeds, homeowners with purchase money loans or "acquisition indebtedness" effectively fulfill their end of the agreement by handing the keys of the mortgaged property back to the bank. The state's Anti-deficiency Laws prevent the bank from forcing the homeowner to pay back the full amount of the loan; however the homeowner must suffer the effects of the foreclosure to enact the Anti-Deficiency Laws.

In those states that utilize recourse mortgages, the homeowner is responsible for the full amount of the loan, even if they walk away from the house, the bank can still require them to pay the shortage. These states allow the banks to take legal actions against any homeowner who attempts to strategically default on their mortgaged home. For this reason, it is particularly important that any homeowner considering a strategic default carefully research their local laws.

Homeowners that Strategically Default should be prepared to live without credit for awhile. I'm hearing the Industry standard hit on a new loan for a borrower with a foreclosure on their credit history(two years seasoning) is 1.5 to 2%. The extra cost of the new loan alone is worth trying to avoid foreclosure. Financial experts estimate that it takes between three and five years for an individual with a foreclosure on their credit history to qualify for a loan again.

There are millions of homeowners with righteous financial hardships depending on the "Dignified Solutions" afforded in HAMP & HAFA. There is no magic wand or get out of jail free card, foreclosure is painful, however if managed properly one can recover quicker. Many individuals feel shame if they are unable to pay back money they borrowed. Others feel fine about doing this, stating that the bank does not seem to have any ethical concerns, so they do not see why they should either.

I feel Licensed Realtors should caution homeowners against Strategic Defaults and provide their clients with critical information that can be used to make an educated decision. Depending on a homeowner's state of residence, age, occupancy issues and personal beliefs about debt repayment, a strategic default might be a viable option.

Here are some interesting articles to read.

http://www.housingwire.com/2010/06/08/strike-strategic-default-mortgage-payments-remain-priority-in-borrower-mentality-nfcc-finds

http://www.housingwire.com/2010/04/06/fannie-mae-sees-strategic-default-on-the-minds-of-underwater-borrowers