Why are strategic foreclosures on the rise? A strategic foreclosure is where a homeowner can afford their mortgage but has negative equity.

Asked by Hannah Fliegel, Larkspur, CA Wed Sep 30, 2009

Generally I am hearing that homeowners tell me that their credit will return faster than the equity in their home. It just seems that more and more borrowers are holding this mindset.

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Eric Michael Abrams - California Real Estate Broker’s answer
Eric Michael…, , San Diego, CA
Mon Jan 25, 2010
I think all of the answers below are very well put and there's little to add. The fact of the matter, in my opinion, is that a home does not define an individual, a family, nor should it be considered the definition of one's success.

There appears to have been a paradigm shift in the psyche of the American consumer. FICO scores are still important to the mindset of the average citizen, though, they are of little consequence if one is struggling to put food on their table, pay their health insurance premium, or support an ill loved one.

Many individuals are realizing there are few legal ramifications from walking away from their homes, aside from a temporary dent to their FICO score. As well, it is now very well known that FICO scores will recover from a foreclosure, and while it may prevent one from utilizing credit in the near-term, this may not represent a material issue to a particular individual.

That is where the paradigm shift has come into play. Credit, is simply not as important to many American's as it once was. Across all sectors of the economy, we're now seeing individuals purchase only what they can afford, and they're considering abstract and excessive purchases to be mere complications to a life that is already overly complicated and difficult, given the economic storm that has gripped our country for several years now.

The American Dream is alive and well, but many were prodded or misguided into believing that the size of their home, the brand of their car, or the cost of their wrist watch were the symbols of their success.

I like to think that there is a lot of soul searching taking place within our great Nation, which I'm confident is on a swift road to economic recovery. We're now seriously looking at alternative energy sources, as a way to preserve our environment for future generations, we're seeing our World as a large global and interconnected community, and we're reexamining what is truly important in life.

One's health, one's family, and one's character are what define an individual, not a computed credit score. People have realized this, and are now simply walking away, rather than dealing with short-sales, etc., for better or for worse.

Personally, I believe a short-sale makes sense for a number of reasons, and it should be attempted before a "strategic foreclosure," but at the end of the day if the short sale does not succeed, I can clearly understand why a family would choose to walk away from their home, with the knowledge that what's really important in life, is not a stationary object, but the sights and sounds of life, which they experience each and every day.

Those experiences are priceless, a home, unending stress, and a bank that's unwilling to negotiate to any degree, well, those things just might have to serve as learning experiences moving forward.

I am extremely bullish on the American economy and the United States real estate market, but when one is in complete despair or has lost their job, they must often take drastic measures. While, personally, I believe we're starting to see some outstanding leading economic indicators, a rebound will take time. To some, weeks may seem like months, and months may seem like years. So, it may make the most sense to "walk" and start over.

I would caution people, that there can be IRS tax consequences to doing so, depending on the loan they have on their home, and to always speak to a qualified and experienced real estate agent or real estate attorney, but after doing so, it may make rational sense from where a borrower is standing, to take the route you've mentioned.

Very good question, and one I've not seen brought up for some time. Thanks for asking Hannah. It would be great to see a few more answers from others in the professional real estate field.

Eric M. Abrams
CA DRE# R01862927
(contact info in profile)
Web Reference:  http://www.ericmabrams.com
1 vote
Steve, , Rohnert Park, CA
Thu Oct 1, 2009
A short sale process can be a pain in the %&@, with life interruptions for home showings, bank negotiations, etc. If successful, also puts them out of the house likely far earlier than the full foreclosure process - especially now with the banks burying their heads in the sand with regard to defaulters. That's a few to many months of 'free rent' a short sale loses - could easily amount to $10K-$15K.

The strategic defaults I'm hearing more of are more like buy and bails with a third party to bypass fraud issues. The 20-30something couple that stops making payments and stockpiles cash. When the actual eviction nears, the parents of underwater couple buy an "investment property". Bailers move into parent's 'investment property' where the rent, surprisingly, equals almost exactly PITI less tax savings. Bailer's stockpile of cash used to pay back parent's down payment, likely with a cushion afterwards.

Their credit is hurt for a few years, but their monthly housing costs are substantially lower and they shed a massive amount of underwater debt. Somewhere in the next 5-10 years they'll figure out how to transfer title from the parents to the kids with minimal costs.
1 vote
David Chiles, Other Pro, Los Angeles, CA
Sat Aug 21, 2010
Thank you for your question about strategic default and negative equity. Strategic default is a viable option for anyone with no equity in their home because the housing crisis is forecast to continue for the next two years before we reach bottom, let alone return to previous levels.

The mindset you spoke of is exactly the mindset that we need to pull ourselves out of this crisis because these people should not have been granted the loans in the first place and doing artifical things to stay in homes that they were not qualified to get in the first place. They are cutting their losses and moving on. At this point the banks need to do the same thing.

Banks created the mortgage crisis by granting loans they knew were bad and are punishing us by holding on to the properties prolonging the recession so they do not have to write down huge losses.
0 votes
Harold Sharpe, Agent, LAKE HAVASU CITY, AZ
Sat Aug 21, 2010
I believe people are easily led, by the news media.
I do know for a fact, in many cases the banks are going after the STRATEGIC foreclosure where there there was money taken out on the property after the purchase.
Having a foreclosure on your credit is a heck of a ding. Around 250 points for all parties on the loan.
That means at best you are looking at 600 credit score for around two to seven years.
Credit cards? Insurance? Business insurance? Cars? Renting a place? getting a job? medical insurance?
Lets face it you are walking out of a house payment that may come back at some point but the alternative is crazy.
In a few years you will see a housing change that will rise more than anyone thought. Of course that is just my opinion and I may be right.

Harold Sharpe - Broker
So Cal Homes Realty
(951) 821-8211
California Department of Real Estate License # 01312992
0 votes
Zachary Betts, , Hesperia, CA
Sat Aug 21, 2010
The negative equity is the major reason I have seen the walk away. These are ones that do not qualify for a loan modification nor will the bank approve a short sale. More and more are looking at walking away. Another reason is people do not know what to do, so much disinformation out there they give up and walk away. Last is my professions fault, Realtors that do not really know what they are doing, confuse customers or mess up the application process for the short sale. A short sale is a loan in reverse proving why people can not afford to pay now, not an excuse to get rid of an upside down house. The hit to ficos scores for a short sale is about 100 points, so if they have a 730 credit score before the short sale now it is about 630 and would not be that damaged. Short sale is not the end all but is a very good alternative for home owners, and short sales do not have the risk of tax consequences that just walking away or abandonment does. Just like anything find someone that knows what they are doing and not just there to make a buck.
0 votes
Bill Gassett, Agent, Hopkinton, MA
Mon Jun 28, 2010
You have answered your own question. Fannie Mae however is now striking back and making it far more difficult for borrowers to just walk away. See why at: http://massrealestatenews.com/fannie-mae-strikes-against-str…
0 votes
Bob Georgiou, Agent, Danville, CA
Mon Jan 25, 2010

There are many resons for this. Some of which has been touched upon here. What I will add is that once a property hits a certain level of negaitive that the economics of digging oneself out versus holding on and waiting becomes self evident.

Here are some assumptions. You live in an area like Antioch (or Stockton) ground zero for foreclosures in Contra Costa and San Juaquin Counties. A buyer bought at 500k with a neg am loan and the home across the street foreclosed at $250k. His payment is around $2500 per month. Assuming 10% appreciation (ha ha ha), the value will take a decade to get back to the $500k alone.

He can rent for half the mortgage payment the same home so that is a savings of $1250 x 12 x 10 or $150k savings not including property taxes, insurance and maintenance.

Without going into all the OTHER consideations such as FICO, credit, risk of spike in interest rate and a serious discussion about that 10% appreciation per year. This buyer could save the difference and buy a home with cash in that same timeline and never have to worry about his FICO.
Web Reference:  http://bob2sell.com
0 votes
Mack McCoy, Agent, Seattle, WA
Sun Jan 24, 2010
More and more. There used to be six, now there are fourteen. Pretty soon, there'll be seventy.

The New York Times has devoted substantial space to this in their business section over the past few weeks, and in reality, it seems that this is of mostly academic interest.
0 votes
Dawn Mitchell, Agent, Boise, ID
Sun Jan 24, 2010
I feel people should consult with an attorney and be prepared before rushing into foreclosure or a short sale. Be prepared, get your finances in order, then decide what is best for your family.
0 votes
Hannah Flieg…, Agent, Larkspur, CA
Thu Oct 1, 2009
Hi Cindi,

Yes, often I encourage borrowers to consider a short sale, however they tell me they do not want to show their financial paperwork and they do not have a hardship which is required in order to a lender to approve a short sale.
I am talking about strategic foreclosures, why are they on the rise?
0 votes
The Hagley G…, Agent, Pleasanton, CA
Wed Sep 30, 2009
It would be much smarter for the seller to do a short sale...it would affect their credit score less than a foreclosure.
0 votes
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