"Help! Get me out from under this house!"
More and more sellers want to escape from their high payments-even sellers who can afford those high payments. Those sellers are pursuing what banks call a "Strategic Default."
The term, Strategic Default, might be new to you, but we are hearing it more and more from the lenders with whom we work, and we are seeing more and more on our clients' files.
Strategic Default means that a borrower or seller, who wants to get out from under their real estate debt, makes a conscious decision to fail to repay their loan-they default, but they are strategic about it.
They have an investment property or a house they live in, and that property's value has decreased so much that they currently own more than the property is worth. When that is the case, the homeowner's thinking sometimes goes like this, "I don't want to be here anymore. I don't want to live in a house for which I owe $100,000 more than it is worth. Forget it! I'm done! I'm going to see if the bank will approve a short sale for me so I can move on with my life."
The difference between a strategic default situation and a non-strategic default is that the borrower can actually afford to make the payments in a strategic default, so the "hardship" piece of the short sale transaction is really weak, even nonexistent. Even though the owner doesn't really have a hardship, he wants to let the house go back to the bank, get out from under the high payments, and call it good. However, he doesn't want to destroy his credit in the process so he pursues a short sale.
So what do the banks think about strategic defaults? Well, they will do them but with a couple of conditions. If your client shows you his financial worksheet, tax returns, and pay stubs--and you see that he is paying his mortgage payments, is still able to pay all his bills, and has money left over at the end of the month-that client is not going to fall into the category of a normal short sale client. That client should expect the lender to treat his file as a strategic default.
In the case of a strategic default the seller should expect one of two requirements from the lender (or a combination of the two):
1. A promissory note. The bank is going to say, "This guy has enough money to pay this loan. We'll let him sell the house and get out from under the house part of it, but we are going to collect on the rest of our money. So, we want him to sign a promissory note." The promissory note could be for a large portion of the banks loss, if not for the entire amount of the deficiency. Often a portion is forgiven which can still work out to the benefit of the seller.
2. Cash at closing. The bank could insist on a contribution from your seller at the closing table to increase the net payoff to the bank above and beyond the amount of the purchase contract.
If you are going to represent someone as their realtor in a strategic default, you need to get him to acknowledge his understanding of the process and the requirements the bank is likely to impose.
When you are doing a quick review of your seller's situation, and you are looking at his financials, have the seller agree at that time stating that he understands he must accept a promissory note if the bank requires it, or that he will, within reason, have to contribute cash at closing.
Believe me, if your seller won't agree to those conditions at the beginning of the process, he certainly won't agree to them at the end!
The bank might just open up that escape hatch in the form of a strategic default, but make sure your client has indicated that he understands the hatch comes with a catch!
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