What exactly is a strategic default? What are the pros & cons? How should one handle the money that is not put towards a current mortgage?

Asked by Jason5470, 91914 Wed Dec 8, 2010


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Daniel Alvar…, Agent, Weehawken, NJ
Thu Dec 9, 2010
Should also mention that strategic defaults apply to just about any type of loan or line or credit. Some folks threaten bankruptcy on their creditors to get them to offer a charge off settlement for pennies on the dollar.

The aforementioned is basically what these "debt settlement companies" employ. This may or may not work in the borrower's favor.

I spoke with one person who filed bankruptcy papers and waited for creditors to call to see what was being offered. Its not completely illegal, but it does raise the ire of moneyed interests which i'm sure petition congress day and night to enact tougher laws against this practice.
1 vote
Daniel Alvar…, Agent, Weehawken, NJ
Wed Dec 8, 2010
Hi Jason,

A strategic default is when a person who has the ability to pay, makes a decision not to do so in the hopes that his or her creditor will try to offer a "work out" (i.e. loan modification or short sale). You should really check with an attorney on the specific laws governing this avenue. Please bare in mind that i am only providing information and this is by no means legal or financial advice.

Pro: One is able to get better terms (in some cases) on his or her mortgage (using inability to pay current payments as leverage)
Con: If bank determines you are not qualified for a loan modification then you will be seriously delinquent and will need to find another way to get current, short sale the property, a deed in lieu (which will hurt you a bit more than a short sale), or worst case scenario: eventually have the property sold at sheriff's sale.

I'm sorry, the second part of your question is completely unethical and i can't answer, but one could devise hundreds of ways to do something with that money.

I hope that clarifies things a bit.

Best Regards,

1 vote
Lisa Cannata, Agent, Osterville, MA
Thu Dec 9, 2010
A strategic default is the decision by a borrower to stop making payments (i.e., to default) on a debt despite having the financial ability to make the payments.

This is particularly associated with residential and commercial mortgages, in which case it usually occurs after a substantial drop in the house's price such that the debt owed is (considerably) greater than the value of the property — the property has negative equity or is "underwater" — and is expected to remain so for the foreseeable future, such as following the bursting of a real estate bubble. Such borrowers are called "walkaways."[
Effects vary by jurisdiction; different countries and different states in the United States treat default on mortgage debt differently, notably distinguishing whether it is recourse debt and non-recourse debt, meaning whether the mortgage lender can pursue claims against the defaulted debtor. Further, mortgage refinancing may be treated differently from an original, un-refinanced mortgage, and mortgages on second homes may be treated differently from mortgages on primary residences.

The borrower after deciding to not make payments any more can live (free of the costs of payment or rent) until the lender forecloses which may take from several months to years. A borrower may use this time to extinguish or negotiate other debt. Mortgage lenders may negotiate with defaulting borrowers to assure maintenance and occupancy of the property until the lender can take title and market the house, and may provide the defaulting borrower with greater than the minimum legal notice to quit (which can be as little as three days) and may even agree to pay a fee to leave the home in pristine condition.

Foreclosure of the borrower's house will result in a negative entry on the borrower's credit rating, possibly making obtaining loans in the future more difficult or more expensive for the borrower. With otherwise good credit a new mortgage from US government agencies will be denied until 3 (FHA) to 7 years (FNMA) have passed since the actual date of foreclosure.

The difference between the value of the property at the time of foreclosure and the amount of the note (assuming the note is larger) is considered by the IRS as "debt forgiven" and may be considered "income" subject to federal income tax. For a short period ending at the end of December 2012 due to the Mortgage Forgiveness Debt Relief Act of 2007, this "phantom income" will not be subject to tax on primary residences.

Defaulting borrowers who walk away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure,” the company announced, adding that the policy goes into effect July 1. “Fannie Mae will also take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments.” The new provisions mean that if you strategically default, you likely cannot get a conforming mortgage for seven years. And if you strategically default in some areas, Fannie Mae will come after you in court.
0 votes
Charles Husen, , Pleasant Hill, CA
Thu Dec 9, 2010
Wow Jason, I would like to commend you on your thought process.

First I would like to say that I am a tax accountant and an Agent Enrolled by the IRS. I am also a real estate broker so I talk to a lot of people about their underwater homes.

When I first talk to people I explain the tax consequences and the difference between a Short Sale, A Foreclosure and a Deed in Lieu of Foreclosure. Then I talk about the business aspects of the negotiations with the bank.

And the last thing that I tell people is that since this is only a business transaction with the bank, they should keep paying their, real estate taxes, insurance, HOA and utilities. AND that it's a good idea to place the interest portion of your mortgage payment in a separate bank account.

Wow, you made the jump to thinking about saving the mortgage payment in a spearate account. Most people would probably immediately spend it.

But let's go back to the beginning. All a "strategic default" means is that you are walking away from your home and letting the bank foreclose. In my opinion this is not the best idea for most people.

First you need to get information about the difference between a Short Sale, A Deed in Lieu and a Foreclosure. Why would you choose to let the bank foreclose when it might be in your best interest to do a Short Sale.

A Short Sale would let you live in the home for probably over a year as you work with the bank to get the home sold. The bank does not want your home so they will be happy to have you maintaining the home and paying all of the costs involved in the home. You get free rent and they get someone to take care of the home: it's a win-win!

So first talk with your bank and ask them what they want you to do. Either a Short Sale or do they want to Foreclose. Let them decide. If they choose to Foreclose then so be it. Some banks are kind of jerks.

But if they say they want you to do a Short Sale then it is your job to find the best Realtor in your area. Since the bank pays for everything in a Short Sale you may as well have the very best working for you.

Next talk to an Enrolled Agent or a CPA about the tax consequences of the "cancellation of debt". Most of my clients don't pay tax on this income and it is possible that you will be liable to pay tax on it either.

To bad you don't live in my neck of the woods. I am the "go to" person in the East Bay to help people through these things. But just get good people to help you. Don't just walk away. I think there are better options for you.

Best of Luck

Charlie Husen
Tax Home Realty
Pleasant Hill CA 94523
(925) 482-7891
Web Reference:  http://www.incometaxhome.com
0 votes
Anna M Brocco, Agent, Williston Park, NY
Thu Dec 9, 2010
Before considering such a scenario, in order to best protect yourself and any other assets you may have, consider consulting with an attorney who specializes in real estste--he/she can best advise, and answer any questions you may have.
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Jane Grant, Agent, Aguanga, CA
Thu Dec 9, 2010
Jason5470: You really need the advice of an attorney. I've seen "Strategic and or Planned Default", work for individuals that really have no other choice because they owe so much on their home and will soon be forced into default, "Foreclosure", anyway. You may have lawsuits, and or other obligations and you will need to speak to a real estate attorney first to really look at your whole financial portfolio, and especially the notes you have on your home, first trust deed, second trust deed, lines of credit. These need careful consideration so that the lender and or lenders will not have recourse. It also matters if the home was refinanced as "Purchase Money", loans have different rules as far as lender recourse.

As you can see there are many different scenarios that can happen and whether "Strategic Default", is good for you or not needs to be considered from a legal standpoint and also a tax consequence standpoint.
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Phil Rotondo, Agent, Melbourne, FL
Thu Dec 9, 2010
Good Morning Jason;

A strategic default is like promising to answer this question and deciding not to. The "pros" is that this vehicle exists; the "cons" are the answers to your 3rd question.

Have a great day!!.
Web Reference:  http://www.321property.com
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