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 â€” the property has negative equity or is "underwater" â€” 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,â€ the company announced, adding that the policy goes into effect July 1. â€œFannie 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.â€ 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.