Foreclosure in San Francisco>Question Details

Hannah Flieg…, Real Estate Pro in Larkspur, CA

Ethical comments please about a strategic foreclosure

Asked by Hannah Fliegel, Larkspur, CA Sun Apr 11, 2010

Borrower purchased a home with an exotic mortgage product back in 2006. Due to negative equity the borrower could not refinance. The lender would not offer a loan modification. The lender would not authorize a short sale without the borrower signing a $80k promissory note. Therefore, the borrower executed a strategic foreclosure. This was a purchase loan in a non-judicial foreclosure state. This soon to be homeowner again after 18 months found a new home to purchase with seller financing. The buyer paid the seller 20% down, both realtors were paid their full commission. Typically FHA would not extend a mortgage for 36 months after a foreclosure. Is it a big deal that this "strategic foreclosure" borrower is so quickly back to home ownership or should he pay for his "strategic foreclosure" and not have the privilege yet?

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David Chiles’ answer
Let's be clear about what caused the financial crisis, bad loans.

It is a shock and outrage that these risky loans were granted in the first place.

As a person with a degree in Finance who has taken classes titled Management of a Financial Institution I know that every bank manager knew or should have known these loans would go bad because the borrowers were not qualified.

When banks give out too many bad loans they are supposed to fail.

The banks, real estate agents, and mortgage loan officers defrauded the public by granting loans they knew would go bad, selling houses to people who they told that the market would never crash, and lying on loan applications.

Strategic default is the right decision in a free market given the circumstances because it allows the market to redetermine the value of the home based on traditional criteria.

Loan modification and other government programs only prevent a recovery and prolong the recession. I applaud all the homeowners who are willing to admit they made a mistake and move on by strategically defaulting.
2 votes Thank Flag Link Wed Apr 21, 2010
First , troubled borrowers have always gone to seller financing or rent to own after they had bad situations;such as bankruptcy,foreclosure or just bad credit. This will continue, but who knows if the lender associated behind the loan that is seller finance, will allow this or enforce a due on sale clause.

The next issue will be what happens when the bank that the strategic default was made finds there are assets available? It just depends on if there were deficiency rights or not in the state the person lives.

Keith Manson
First Weber Group
Certifed Distressed Property Expert
Metro Milwaukee
2 votes Thank Flag Link Thu Apr 15, 2010
Hmmm. Our protagonist borrowed money to buy a home, deliberately defaulted on the loan, found someone else to loan them money . . . I'm not sure where ethics plays a part in this.

People are allowed to lend money to deadbeats. Aren't they?
2 votes Thank Flag Link Thu Apr 15, 2010
I thimk it is terrible. Just because the law hasn"t caught up with latest way people are manipulating the system, doesn't make it right. I would not have represented either party.

I agree with Dan on TARP. I certainly did not and do not agree with my tax dollars being used to "bail" industries out and still don't, I know this will be unpopular giving the number of realtors on this site, but I also don't agree with the housing stimulus. The government needs to stop the spending and the program creation. It is getting crazy.

Just my two cents,
April Tavares, GR
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2 votes Thank Flag Link Sun Apr 11, 2010
Strategic foreclosures are unethical.

They're a deliberate rip-off of lenders for the convenience of owners.

There are plenty of legitimate reasons why an owner might face foreclosure: death of a spouse, divorce, loss of job, reduction in pay, illness, and so on.

But when an owner is able to pay but chooses not to, that's unethical. And keep in mind that the owner in this case, and in other cases of strategic foreclosure, voluntarily agreed to the mortgage product, exotic or not. The terms were there. They were spelled out. If the owner is alleging deception on the part of the lender, then the owner should take the lender to court. But there was no deception. There was generally greed and a speculator's mentality that values would continue to rise.

Harsh? Yes. True? Yes.

The owners executing a strategic foreclosure are asking the lenders to absorb the loss of a property's value in a declining market. Let me pose this question: If the property's value had risen and the owners had made a profit, would they have shared the profits with the lenders? If the answer is "no"--and we know it is--then the owners want the best of both possible worlds. They want all the profits for themselves, and they want the lenders to take all the risk for any loss. That's unethical.

The other facts in your question are irrelevant. Ethics has nothing to do with how much the buyer paid the seller. It has nothing to do with whether both Realtors were paid their full commission. It has nothing to do with whether the lender would offer a loan modification. It has nothing to do with whether the mortgage was "exotic" so long as the borrower understood and agreed to its terms.

It all comes down to the individual choosing to eliminate the negative equity by deliberately violating an agreement he willingly made. You tell me: Is that ethical?
2 votes Thank Flag Link Sun Apr 11, 2010
Don Tepper, Real Estate Pro in Burke, VA
If I was in charge my solution would be simple. A minimum of 10 years before buying again after foreclosure. No exceptions. After 10 years you might be able to. But you would only be able to buy with at least 20% down or whatever the highest conventional mortgage asked for.

The scenario above if carried out (literally) millions of times is just asking for a future financial problem that could be avoided.

Just so you know I am being fair, the banks should not have gotten tarp. They stay afloat on their own or get sold off for debts. This whole situation and solution is screwy and wrong.
2 votes Thank Flag Link Sun Apr 11, 2010
Very well stated Mack. I couldn't agree more.

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1 vote Thank Flag Link Sat Apr 24, 2010
Coolio, I don't agree with you.

Mortgage loans are not a necessity of life. Nobody has to take out an "exotic" loan, and the majority of people who did were, truth be told, bad credit risks.

I'm not exactly sure why any of us believe that a lender should be obligated to renegotiate the terms of the loan, simply because they borrower doesn't feel like paying.
1 vote Thank Flag Link Sat Apr 24, 2010
Hannah, the person saved a 20% down payment which means they obviously could have paid their mortgage.

The fact that the loan had insurance on it is irrelevant. Having insurance changes nothing when it comes to the commitments made. Does having insurance and the owner hurting an insurance company instead of a bank make a difference? I think not. A person made a decision to violate a contract they made knowing what they were doing.

The problem is not the financial loss someone on either side of the transaction incurs. The problem is the mindset that led to that loss. After all, once someone decides that their contracts and word mean nothing they will not choose to live up to their other requirements either.

If I choose to violate my promise for $200k what is to stop me from doing the same thing just because I do not feel like it? There is no difference and honest people know it.

p.s. when can I get paid to not be underwater on everything I buy? Nothing has the value after I take it home that it did on the store shelf or dealers lot.
1 vote Thank Flag Link Wed Apr 21, 2010
Where'd the buyer come up with the 20% down?
1 vote Thank Flag Link Wed Apr 21, 2010
I'd call that strategic financial management.
It's not ethics, and you don't have to be jealous.
If it was you - what would you do? Would you really accept many years of suffering because you felt you must be punished? Or would you do the best that you could for you and your family and settle the best you could and move forward with your life?
I feel there is an unbelievable number of people just like this guy out there right now.
Those that wil be in a position to offer seller financing or lease options/purchase will be in a very good spot in the years to come.
It's a changing world.
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1 vote Thank Flag Link Wed Apr 21, 2010
Is -what- ethics or jealousy, Hannah?
1 vote Thank Flag Link Wed Apr 21, 2010
Yes, David, and in most circles, that's called, "Fraud."

It's one thing if a bank wants to make loans and keep them on its books, although they are obliged to establish underwriting standards, and the Board has every reason to fire employees who violate those standards.

It's another thing to pass those loans off to a third party as meeting underwriting standards, that's where the "fraud" thing comes in.

And that's really what caused the financial crisis - the loans were not properly priced for resale.
1 vote Thank Flag Link Wed Apr 21, 2010
Who are any of us to judge?
I personally don't find any "ethical" issues associated with a home purchase or default - strategic or not. It's a financial decision, not a test of moral ability. He did what he needed to and lending was available to him. End of story.
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1 vote Thank Flag Link Wed Apr 21, 2010
Your question hinges on the ethics of this situation. As long as the seller, who is carrying the note on the property, knows the borrower’s full financial history, then there is nothing improper about this transaction.
For those who feel the borrower should be punished, recognize that there are two sides to every story. We only know that the borrower was under water with the first purchase, but nothing else. (Had they lost their job? Had a death in the family?) Nor do we know the source of the new down payment. (Was it a gift from the borrower’s parents? Was it an inheritance? Perhaps it was a big signing bonus at a new job?)

As for the new purchase, just like a cheating spouse who marries the mistress (or mister), everybody knows the bargain and how they got there. Sometimes it works out and sometimes it doesn’t; who is anyone else to judge their lives or decisions? (The dumped always an opinion, of course, but they really aren’t objective.)

Moreover, my opinion is that society is better off with people owning homes in which they live. That belief has fueled real estate since the early twentieth century and, hopefully with some market balance, will continue to into the future.

Jason Allen-Rouman
Sotheby’s International Realty
DRE# 01831809
(415) 641-7800
1 vote Thank Flag Link Thu Apr 15, 2010
My opinion does it truly matter? If he was able to obtain a loan then who cares.
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1 vote Thank Flag Link Mon Apr 12, 2010
Why do you honestly believe measures to forgive tax on short sales , dil and foreclosure are enacted. Gov. and lenders visible must appear their efforts will make a difference. You can`t tell me there isn`t a solution that works . Ask someone who`s been declined a re-finance or loan modificaton . They are strung along with nothing to show after many frustrating months. Ask yourself why these programs were designed to fail . Strickly advertisement.!! the appearance of doing something and accomplishing nothing. There is absolutely no substance to anything that comes from Washington. Ask a lobbyist. They run your Gov. They circumvent for their best interest any proper remedy for the people. Everyone stop believing you have a Gov. that is truthful.They win the war by dividing and conquering public opinion.
1 vote Thank Flag Link Mon Apr 12, 2010
needs to be stronger penalties for folks taking these actions

That's why I'm against the legislation that waives tax consequences for people who walk away from their home.
1 vote Thank Flag Link Mon Apr 12, 2010
Mr. Woo I appauld your observation of those un- professional in your field. In wartime I`d kick that mentality right out of my foxhole. Thank You, Sir
1 vote Thank Flag Link Mon Apr 12, 2010
I think all forclosures are "strategic" and find no unethical or immoral behavor attached to it. We are in the business of real estate. The lenders had the right to underwrite the loan anyway they choose. They offered buyers ridiculously easy loans to get into, and assumed that their loan was properly secured because the market would never go down. They were wrong and they are paying for their poor judgment. The buyers made poor judgments as well, but some simply think they have not suffered enough for that poor judgment.

The borrowers are given a set of rules. Sometimes it works for them, and sometimes it doesn't. If they follow the rules and it works to their advantage, where it the immoral conduct?

And asserting the borrowers should be penalized in future for a foreclosure? Its the market that will determine whether, all things considered, including the supply of money and the state to the market, whether these or any other buyers who have gone through a foreclosure should be able to borrow again.

I must say that I am a bit surpised by some of the comments here by professional who make their living at real estate.
1 vote Thank Flag Link Mon Apr 12, 2010
He SHOULD NOT be purchasing another home. I will lay money that it will also be foreclosed on.
1 vote Thank Flag Link Mon Apr 12, 2010
Just possibly people feel trapped in staying in a location they have no control of . Maybe they`re health reasons, job situations necessitating decisions. Lenders can`t be expected to understand. The government has no excuses.This is a systemic problem. Not being able to have self determination where one chooses to live may also play a role in owners selecting strategic foreclosure. Possibly I never intended to stay here for the next 10 to 15 years. Nobody seems to know if and when change will occurr. I don`t believe the idea of home speculation was the homeowners. Those who oppose this chose may find themselves making an unpopular decision someday relavent to their family`s need. WHERE WAS REGULATION ? IT MOVED ASIDE TO MAKE GREED PROFITABLE
1 vote Thank Flag Link Mon Apr 12, 2010
This brings up an interesting question that I first read about in an op-ed piece in the San Francisco paper. The position of the article was that the "people are made to feel that it is a "moral" failing to default on a mortgage contract. To default on a debt is almost a sin. Yet banks and large institutions do it all the time for no other reason than to get a debt off the books and the lender also get a tax benefit from it. No morals there.

So the same instituions that have pushed people to suicide over defaulting on a debt are not worried if they default.

To answer the question I'd say no, there is nothing wrong with the entire scenario. The seller wants to sell and the buyer wants to buy. The seller, as long as they are aware of the risks and are prepared to get the house back if the buyer decides to walk away again life goes on and I don't pass moral judgement on the little people - only on the coprorate people - who now have the right to contribute as much or more than people in campaigns.
1 vote Thank Flag Link Mon Apr 12, 2010
Jed Lane, Real Estate Pro in San Francisco, CA
Sign me up. For all those who believe this action is immoral and criminal you`re part of the problem.
1 vote Thank Flag Link Sun Apr 11, 2010
As long as he is working within the current system - we may not agree with the thought of him purchasing another home - but this is America -he has the right to do so.

Gerard Dunn
Associate Broker ~ Over 27 Years of licensure
Serving Maryland, DC and Northern Virginia
1 vote Thank Flag Link Sun Apr 11, 2010
Yeah, I'd be able to save a lot of dough if I didn't fulfill my payment obligations, too. That's why, Hannah, I call people who "execute a strategic foreclosure," deadbeats.

All the best,
0 votes Thank Flag Link Sun Apr 25, 2010
Thank you for all those fabulous comments and insight. Personally I have mixed feelings on this subject which i why I reached out to the Trulia community to see other's views and thoughts and I truly appreciate the depth to which each of you share your opinions.

When the borrower executed a Strategic Foreclosure he moved in with his family and stayed there for 18 months, during which he was able to save up a bunch of cash in effort to return to home ownership. This is where he was able to come up with the 20% down payment.

To Barry, the buyer is rebuilding his credit rating because he is making his payment to a note servicer who does report the monthly payments to the three main credit bureaus. You will also all be happy to know that this borrower's credit score is up to 748 already by making his monthly payments and meeting his other obligations with his credit card payments.

The new HAFA program that was introduced this year is voluntary and the banks do not have to participate. It is going to be very difficult for a borrower to short sale a home they live in and move down the street to a less expensive home and obtain immediate institutional financing. The new lender may have overlay guidelines and may not lend to these folks, we will have to see how this program rolls out.

Thanks to everyone for your contributions. I am concerned about the rise in strategic foreclosures that are in the pipeline and trying to wrap my mind around it all.
0 votes Thank Flag Link Sun Apr 25, 2010
Hello Hannah,
Strategic Defaults are NOT Strategic. Learn more about exactly why Strategic Defaults are NOT Strategic by visiting our short sale vs. foreclosure website, and clicking on the RESOURCES tab. We have packed our website full of useful pertinent information for homeowners, which includes coverage of the new HAFA program. That's great to hear the seller found owner-financing on their home of choice. Too bad the regular payments won't be reported to the 3 credit bureaus -- yet they could prove a mortgage history on down the road as long as they save their mortgage payment check copies.
0 votes Thank Flag Link Sat Apr 24, 2010
Complicated. It's obvious that a borrower should not simply renege on the contract, and foreclose strategically to avoid paying back their debt.

That said, the lender sold an exotic mortgage and refused to modify the loan. This shows a basic unwillingness to work with the borrower (bad faith). Depending on the precise terms of the original loan, it may also constitute unethical business practices.

I agree with comments that, if the borrower had 20% to put down on a new house, they could have kept paying the original mortgage. However it also seems that if the lender was unwilling to help the borrower figure out a more affordable mortgage deal, they are at least partly responsible. Overall, a preferable course of action would have been for the borrower to seek legal representation, and push for a more affordable mortgage with the original lender. (I guess the lender had already set their sights on the new house and was finding excuses, ethical or not, to back out of the original deal.)

Overall, it would help to know the original loan terms. Did the borrower understand their exotic mortgage? Were they enticed into a financially unsustainable situation? The point being, was the negative equity the lender's or the borrower's fault? Certainly there is an ethical 'black hole' surrounding the original situation.
Whatever the case, the borrower took an unethical path out of the situation. They should not have retained the 20% down payment on a new house, or been excused from making payments they could have made so soon after a bankruptcy. I can imagine exceptions, such as an inheritance from a parent who died after the bankruptcy, but they are unlikely.

All in all, I'd say the borrower almost certainly acted unethically, but it's very possible the lender also acted unethically.

(Incidentally, this is a prime time for unethical lenders to approach them once again: a) they are not eligible for bankruptcy for another 5 years, and b) they have shown an inability to manage debt - which spells 'quick bucks' to loan sharks.)
0 votes Thank Flag Link Sat Apr 24, 2010
I think real estate professionals put their ethics on the line when they vote on this issue. My vote is that Hannah's borrower / buyer is a deadbeat. A "strategic foreclosure" is another way of saying, "reneged on their debts."

Although I enjoy the idea of Realtors(r) getting paid their full commission, and I absolutely agree that if someone is willing to finance a deadbeat, it's their right and privilege, a deadbeat is still a deadbeat.
0 votes Thank Flag Link Sat Apr 24, 2010
Thank you for all of you who have been responding to this question. A lot of good insight and passion. The borrower's first loan actually had 'mortgage insurance' on the loan. Not PMI but actual mortgage insurance (Credit Default Swaps/Derivatives) This means that if the borrower defaulted the lender would get paid. The borrower did default on the first mortgage and executed a strategic foreclosure and the lender got paid. This is an example of how credit was manufactured on wall street and caused a housing bubble because of cheap credit leads to expensive assets. )

The former home owner then saved up money and moved into a new property with a 20% down payment and the seller is carrying financing. You will all be happy to know that he has been paying his new mortgage for well over a year and the seller is happy because where else are they going to get a 7.5% return that is secured against a quality asset?

Is it ethics or jealousy?
0 votes Thank Flag Link Wed Apr 21, 2010
Strategic Foreclosure seems to be the newest buzz word. Home owners who are "underwater" another buzz word, will become even more creative, lenders and folks with money will find new ways to lend it and spend it. The ways to buy and sell real estate are changing, becoming much more global and technology fueled.
Maybe what seems questionable now, will become the new normal. Home buying will once again swing up, only to come crashing down because of the "new normal" and the cycle will go on and on. Up and Down..

Laura Reilly- Foreclosure “INVEST”igator USA
“I have a problem with too much money. I can't reinvest it fast enough” Robert Kiyosaki
0 votes Thank Flag Link Wed Apr 21, 2010
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