Strategic Default and Foreclosure Options

by E.G.
(Sacramento, CA)

What exactly is strategic default and how does it work as a foreclosure option? My husband and I are thinking of walking away from our house all together and just be done with it. We've been trying to get a loan modification through National City, which is now PNC, since July 2009 and we've been given the run around. Our house is now in foreclosure (PNC has filed, but has been postponing our sale date due to further review and a huge backlog) and we're exhausted and drained from trying to figure out how to save it and if it's worth it anymore.

Can you explain strategic default, how it works, and what the consequences are? We have a 1st with PNC for $498k (original purchase loan), a 2nd with Chase for $100k, our house is worth $536k. We have other properties -- one with positive equity, one with negative equity. Our hardship is that my husband's hours have been cut so our income has decreased, we've got 2 kids in college, one of our rentals is generating negative income, and our house is upside down in value.

Any thoughts from anyone reading this would be appreciated. We know we're not the only ones suffering the same fate, but we are tired from fighting the fight and are ready to give up...

Foreclosure Options Answer:

"Strategic Default" is a newly coined term that has cropped up in today's current mortgage and housing meltdown. It basically means "voluntary planned foreclosure". It is when a borrower or homeowner decides to walk away from a mortgage loan obligation because they determine that it makes the best financial or "business" sense.

This happens if they do not anticipate a personal financial recovery any time soon, and would rather have the bank foreclose on their home, take the credit hit, but gain freedom from a mortgage loan payment they can no longer afford.

The financial relief affords them the ability to start over with a clean slate even if it'll take some time and work to restore their ruined credit.

Strategic default makes sense for homeowners who have little to lose by walking away. These are folks who put little to no money down upon purchase of the property, and by walking away, will not have any further negative consequences like a deficiency judgment or tax liability.

In your case, there are a couple of things to consider if you're thinking of just letting the bank foreclose:

1. Potential Deficiency Judgment from your 2nd mortgage from Chase

If you just walk away and let PNC (your 1st mortage) foreclose on your home, assuming that it is your primary residence, you will have no further obligation moving forward with PNC. California law states that your 1st mortgage lender is not allowed to file a deficiency judgment if they exercised the "power of sale" clause in your contract, and foreclosed on your home through a trustee sale. HOWEVER, in your case, you have a 2nd mortgage with Chase, which will be extinguished or wiped out in the event of a foreclosure from PNC. If your Chase 2nd mortgage loan was obtained during the original purchase of your property -- known as a purchase money loan, you may have escaped a potential deficiency judgment, BUT if it was obtained through a refinance, Chase has the right to file a deficiency judgment against you if their loan is wiped out. Lenders used to rarely file deficiency judgments, but in today's financial crisis, they have become quite a bit more aggressive and are more likely to do so in order to recoup their investment.

Here's the silver lining...

A deficiency judgment is technically an unsecured loan, so it can be wiped out through a bankruptcy filing, or can be settled for pennies on the dollar through skilled debt settlement negotiations. But keep in mind that if you have equity in one of your rental properties and you are not delinquent on your payments, debt collectors will use this against you. They will insist that you have assets you can use to pay them. Such assets will also complicate a bankruptcy filing so it may not be your best option.

Please consult with an experienced real estate attorney who is a foreclosure and bankruptcy expert for advise on your particular situation. It will be worth the consultation fee to know your legal options within your state and local area.

2. Wait and See if Your Loan Modification is Approved

It may be worth it to hang in there and continue to wait and see if PNC approves your loan modification. Yes, it's been a very slow and draining process, but in the mean time, you've essentially been living in your home for free and hopefully you've been saving your money just in case you will have to move and need it for your new "start over" plan.

A loan modification approval from PNC will allow you to pursue the same with Chase, who will, by that point, have good reason to also modify their rate and terms to make your payments affordable.

Even if your payments are only lowered for the usual 5 years, this gives you enough breathing room and time to plan an exit strategy. Who knows, maybe the market will recover enough for you to be able to sell your property 5 years from now at a price that will pay off all your lenders and give back your downpayment so you can break even or maybe even do better! Your income may increase again and allow you to afford all your monthly financial obligations and not have to sell your property at all. Whatever you decide to do, you will have the time to do it...and be able to execute your plans without the stress of a looming foreclosure.

Hope the above helps. If you have any more questions or comments, please do post again.

All comments are welcome.