Last Friday I posted on the fact that 26% of all mortgage defaults are “strategic” -- where the homeowner can afford the mortgage but chooses to walk away, most often because of negative equity (when the homeowner owes more on the mortgage than the home is worth).
I ended with the question “What can you do about it?” To answer that question, and to get the inside scoop on the strategic default trend, I talked with a local real estate attorney. Here’s what I learned:
Credit score implications
Most mortgage lenders won’t lend to people who have had a foreclosure within the last 4 years; so if you do a “strategic default” plan on renting for 4 years.
While you may be able to get a mortgage in 4 years, the foreclosure stays on your credit report for 7 years.
Interestingly, it’s not the foreclosure or short sale that does the most damage to your credit report -- it’s all the late payments you rack up as you move toward foreclosure or a short sale.
Fortunately, those late payments will be off your credit report in 2 years.
Legal implications
In Arizona, there are two “anti-deficiency” statutes that protect the homeowner’s wages and other assets from the bank. In other words, if you default on your mortgage loan, the bank can take the collateral for that loan (the house) but has no other recourse. Not every state has those anti-deficiency statutes.
If you have a second mortgage, as long as it was used as “purchase money” -- to buy the home (as in an If you default, the bank has two options: 1) it can sue you in court; or 2) it can foreclose through a trustee sale. The second, as the cheaper and faster option, is the most common.
If you decide to do a strategic default, you’ll probably have about 6 months from when you stop paying until the home is foreclosed. 10 months is not uncommon. But the only time guarantee is that the bank is required to notify you 91 days in advance of the trustee sale (the date the home will actually be foreclosed).
Tax implications
There is a “forgiveness of debt tax” but it doesn’t apply as long as you’ve lived in your home for at least 2 of the last 5 years and the mortgage was used entirely as “purchase money” -- to buy the house.
There is an additional form you’ll have to submit to the IRS. Talk to your accountant.
Other options
If you make the decision to do a “strategic default” you should be sure that you’re comfortable with foreclosure as a possible end result. That said, there are some other options you could pursue with the lender.
One alternative to foreclosure is a short sale. You sell your home as you normally would, but the bank has to agree to the purchase price -- which will be some amount less than what you owe on the home. The bank takes a loss on the difference between what you owe and the proceeds of the sale.
A short sale will still be a negative mark on your credit, but not as negative as a foreclosure.
In some cases, you could negotiate with the bank not to report the late payments (those payments you miss between the time you default on the loan and when the short sale goes through) to the credit bureaus.
Another option is to negotiate down your mortgage principle. If you’ve decided already that you’re willing to accept a foreclosure, if that’s the end result, you could call the bank and ask them to reduce the principle you owe on your mortgage to the market value (or close to). If you no longer have negative equity (or as much negative equity), that should eliminate the reason you decided to do a “strategic default” in the first place.
I have to say that I am not an attorney and none of the information I’ve presented here should be construed as legal advice. If you have questions about foreclosure or “strategic defaults” or are thinking about defaulting on your mortgage, consult with a legal professional.
What do you think? Have you thought about a “strategic default”? Click on the “Comments” link below and join the discussion!
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