'Strategic default' growing in popularity — but it's risky
By CHRISTINE DUGAS
More homeowners are walking away from their mortgages, even if they can keep up the payments. Falling into foreclosure — voluntarily or not — has become less taboo for many people as they have watched their house values tumble far below the amount they owe, putting them "underwater."
Purposely defaulting on a mortgage, often called "strategic default," may be a very rational personal finance decision, but it's not without major consequences. And it's not necessarily the best option for anyone underwater who can afford to make monthly mortgage payments but who does not want to wait up to 10 years for the housing market to turn around.
Many factors must be considered, including a key one: which state you live in.
Shelby and Scott Robinson, from Manteca, Calif., married in 2006 and purchased a starter home about a year later for $310,000. It plummeted in value.
They realized they would have to stay in the home for far longer than expected to gain any value back. The area also did not hold much job flexibility for Scott, a restaurant chef. The couple spoke with financial advisers and considered a strategic default.
"It's not about not having money," says Shelby, a purchasing manager for a shoe company. "It's about not throwing money away."
In the end, they opted for a short sale, an agreement with a lender to sell the house for less than what is owed. They chose that route because it's not as harsh on their credit score as foreclosure. They quickly found a buyer and are awaiting bank approval for the sale. The buyer would pay $103,000 if the sale is approved.
If you go through a strategic default, your lender may file a lawsuit against you, called a "deficiency judgment," to recoup losses. The lender can demand payment for the unpaid balance: the difference between what you owe, including the foreclosure cost, and the fair market value of the home.
Lenders don't always bother to go after people who have been forced into foreclosure. But in some states, such as Florida, they have five years to do so.
"I've been hearing that lenders are becoming more aggressive about going after deficiencies in homes that they had to take back," says Gerri Detweiler, co-author of Debt Collection Answers. "Then you can essentially be paying for a home that you no longer have."
Some homeowners decide to file for bankruptcy after they go through foreclosure because that can wipe out a deficiency.
But that may not be necessary, because some states have non-deficiency laws that prevent such lender action.
"That means that the lender only can take back the home and cannot sue the borrower for the deficiency," says Jon Maddux, CEO of YouWalkAway.com. For a fee, his company helps guide people through foreclosure. Among the non-recourse states are California and Arizona.
But even in those states, lenders can still go after you for a second mortgage. And if you had refinanced the original mortgage, the lender may also be able to file a deficiency judgment against you.
Even if a homeowner can avoid a deficiency judgment, a strategic default will cause other problems — chief among them a drag on credit scores.