Strategic Default

Given today’s housing market many Arizona homeowners have found themselves “upside down,” oftentimes more than 50%!

As a result such homeowners are considering “walking away” from their mortgage(s) and home. The reason someone may choose to do this is because they feel that, from a financial perspective, it simply does not make sense to keep the home.

Many homeowners are coming to the realization that they may potentially be making high mortgage payments for the next 20-30 years on a property that may never be worth what they originally paid for it.

So, What’s The Challenge?

The age-old argument against walking away from your home is that it is simply immoral and/or irresponsible to do so.

But one must question what really is the irresponsible thing to do – not making the monthly payment to your lender or continuing to make the payment (on a home who’s value will not reach a break even point for quite possibly 10-20 years) rather than saving the funds for your family, child’s college, retirement, etc.? This dilemma is a difficult one for homeowners to face.

If you are considering walking away from your home, do not simply let the house go to foreclosure. At the very least salvage your credit and limit your legal exposure and explore your options through a short sale.
MyPadAZ specializes in handling Strategic Default scenarios. The strategies and processes differ from that of a traditional Short Sale, and it is highly recommended that you consult with a professional that is experienced in handling such matters.

For more information regarding Strategic Default through utilization of a short sale, Homehelper Consultants strongly recommends that you read a discussion paper written by University of Arizona law professor Brent White entitled “Underwater and Not Walking Away: Shame, Fear, and Social Management of the Housing Crisis”.

The following is a link to Professor White’s paper: http://www.sacbee.com/static/weblogs/real_estate/SSRN-id1494467.pdf

Here are some excerpts from the paper:

“…Most homeowners choose not to strategically default as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to encourage homeowners to follow social and moral norms related to the honoring of financial obligations – and to ignore market and legal norms under which strategic default might be both viable and the wisest financial decision.” (ABSTRACT)

“While such behavior may appear irrational on its face, behavioral economists explain that underwater homeowners simply suffer from the same kind of cognitive biases that lead individuals to make other suboptimal economic decisions. Underwater homeowners aren’t knowingly making bad choices; they just can’t cognitively grasp that they would be better off if they walked away from their mortgages.” (PAGE 1)

“…Individual homeowners tend to ignore market and legal norms under which strategic default might not only be a viable option, but also the wisest financial decision. Lenders, on the other hand, have generally resisted calls to modify underwater mortgages despite the fact that it would be both socially beneficial and morally responsible for them to do so. This norm asymmetry has lead to distributional inequalities in which individual homeowners shoulder a disproportionate burden from the housing collapse.” (PAGE 2)

“While the actual financial cost of having a poor credit score for a few years may be hard to quantify, it is not likely to be significant for most individuals – especially not when compared to the savings from walking away from a seriously underwater mortgage.” (PAGE 12)

“…The costs of default are not nearly as extreme as these same institutions typically misrepresent them to be. In reality: homeowners face no risk of a deficiency judgment in many states or for FHA loans regardless of the state; lenders are unlikely to pursue a deficiency judgment even in recourse states because it is economically inefficient to do so; there is no tax liability on “forgiven portions” of home mortgages under current federal tax law in effect until 2012; defaulting on one’s mortgage does not mean that one’s other credit lines will be revoked; and most people can expect to recover from the negative impact of foreclosure on their credit score within a few years.” (PAGE 33)

Is A Strategic Short Sale For You?

For the past few years the majority of MyPadAZ’s short sale clients – those homeowners that sold their homes despite the fact that they owe more on it than it was worth – were experiencing what the major lenders consider to be “traditional” hardships.

These homeowners suffered financial distress due to a loss of job, reduction in income, medical hardship, divorce, and other income reducing and/or cost increasing occurrences. As a direct result of the “traditional” hardship, the homeowner was unable to continue to make their mortgage payments and thus had to find a solution to avoid foreclosure.

Many of our clients would first attempt a loan modification only to later realize that the modification, if it was even approved, did not actually better their financial situation. It was then that they’d contact our offices and we’d list their property, secure a purchase contract, and negotiate a short sale with their lender(s).

Over the past 6 to 9 months we have noticed a significant shift in the types of financial hardships experienced by our clients. On average I speak with anywhere from 2 to 10 homeowners per day. Of these homeowners, I estimate that about 50% are NOT experiencing the traditional hardships noted above. Rather many of these individuals CAN afford their monthly mortgage payment. As a matter of fact many of them are actually making more money this year than they did last year! Clearly, the monthly payment is not the cause for financial distress.

What these homeowners are most concerned with is the fact that they’ve lost anywhere from 30% to 70% of the equity in their homes over the past few years. Each month they make a payment on an asset (their home) that is continuing to depreciate with no true end in sight. They feel like they are throwing “good money after bad” whereas that money could be going towards their retirement or their children’s college tuition. They recognize that even if the market stabilized today historical appreciation rates are roughly 3-4%. The math is pretty simple – if you’ve lost 40% of the value in your home you’re looking at over 10 years before you can break even on your “investment”. From a purely business perspective this sort of predicament is unacceptable. As a result homeowners faced with this new era hardship are utilizing a technique that is becoming much more prevalent by the day – the strategic default.

In simple terms, a strategic default occurs when a borrower decides to stop making payments on a loan despite having the financial ability to make the payments. If one stops making payments on their mortgage loan then, per the terms of the loan agreement, the homeowner’s lender has the ability to exercise its right to foreclose on the property securing the loan.

Why Would Someone Stop Making Mortgage Payments?

There are multiple answers to this question but the most common response is that very few lenders will even talk to homeowners about financial options and mortgage relief if the homeowner is current on their loan. Lenders are just not motivated to work with a homeowner whose loan is “performing”; that is the payments are being made on time each month. Because of this fact many homeowners opt to fall behind on their payments just to spur a conversation with their lender. Another reason why someone stops making payments on their home is become they come to the conclusion that in making the monthly payments they are only doing so for sake of their credit score. They are not paying down the balance of their loan with each payment and the property certainly is not a solid investment at this time (assuming that it is significantly underwater).

Homeowners are deciding that it is worth the credit hit to get out from under their home and start rebuilding their financial lives. They are tired of delaying the inevitable. In a short sale a bank wants to know that a hardship exists. It does not consider the loss of value to be a hardship. Most homeowners disagree with this perspective. So how does one short sell their home if they are not experiencing a hardship that the lender deems worthy of consideration? By strategically defaulting on their mortgage payment.

The fact of the matter is this…the further one falls behind on their mortgage payment the closer they are to foreclosure. The closer one is to foreclosure the less relevant their actual hardship becomes to their lender! The lender is faced with a decision regardless of the homeowner’s hardship (or lack thereof). It is either going to work with HHC on a short sale and net $X or it is going to foreclose and net $X minus $30K-$50K (on average a foreclosure costs a bank roughly $30K to $50K). The “Strategic Short Sale” technique is on the rise as lenders refuse to assist those homeowners that can technically afford their monthly payment but have lost a significant amount of value in their home over the past few years. If a Strategic Short Sale is something you are considering MyPadAZ strongly encourages you to consult with your attorney and accountant as there may be potential legal and/or tax ramifications.

MyPadAZ partners with a local law firm and is more than happy to help coordinate a meeting to discuss the possibility of a Strategic Short Sale if you desire!

How Can We Help?

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s