If you’re reading this article, there’s a decent chance you have a mortgage that is underwater and are considering walking away in a strategic default.  i.e., you want to stop paying your mortgage, get rid of your property, and move on with your life without having your financial future destroyed.  In my Strategic Mortgage Default System I teach you how best to plan for achieving this objective.

There is a Process – That is a Bit Strained Right Now

Certainly if you are considering strategic default, you’re not alone. Millions of homeowners are having the same conversation in their heads right now.  Thus you may be wondering what actually happens if you stop paying your mortgage.

A process starts when you stop paying your mortgage.  The exact details vary from lender to lender, but the general process is quite uniform.  Of course, in the current real estate crisis the sheer volume of mortgage defaults has turned many bank policies upside down, so it is entirely possible that things will not follow the process that they generally do.

For example, banks are so far behind on their caseloads that often they do not take any action on non-payment for many months longer than they normally would.  You cannot count on this, but a delay means that you can probably stay in the house and live mortgage free for many more months, all the while saving the money you would have spent on the mortgage or rent.

Generally speaking, if you miss a payment, the bank will let you know right away that you have missed it – oftentimes with the “nice-guy” attitude that there may have been a mix-up in sending the payment that caused them not to receive it.  If you ignore this warning and continue not to pay, you will eventually start hearing frequently from the bank’s collections department. 

The collections department will be focused only on when and how much you can pay.  If you have made the decision to stop paying altogether and seek a solution, you would typically inform the collections department that you cannot pay now, and that you do not anticipate being able to pay. i.e., that you want to seek a “workout” on the mortgage.  They will likely inform you that you can speak to their “workout department” or “loss mitigation department.”

Usually the collections department and the workout department are quite unrelated, so even while working with the workout department, you will likely be annoyed by continued calls from the collections department.

Won’t They Just Foreclose on Me?

Foreclosure definitely will happen at the very end of the road if you just stop paying your mortgage and do nothing else.  But as I will discuss in future articles, there are several other common options that may be available to you that will prevent foreclosure.

While you are working on a mutually acceptable solution with the workout department, the foreclosure process will be starting to move forward behind the scenes.  Again, based on the enormous volume of delinquent payments at these banks, it may take MUCH longer than normal for this to happen – possibly not even for a year or more, in some cases.

You should typically assume that within about 2 to 4 months of missing your first payment, the lender will initiate foreclosure proceedings. You will start receiving formal looking documents, basically outlining that you are in default of the loan and that the bank has initiated a foreclosure suit against you.

The laws and processes surrounding how foreclosures are pursued vary from state to state, but it good universal advice to say:

DO NOT IGNORE THE FORECLOSURE NOTICE WHEN IT COMES.

Once you receive the foreclosure notice, you are well advised to have a foreclosure attorney take the case for you. By having an attorney take action on your behalf, you can generally forestall any truly negative actions on the foreclosure for many months – often long enough to get your workout handled, and keep you in the house for free in the meantime.

If you plan and execute your strategic default strategy well, then while the foreclosure suit is slowly plodding along, you will be coming to a successful workout agreement with the bank via, e.g., short sale or deed in lieu of foreclosure. If a successful workout cannot be arrived at, then eventually the foreclosure will grind on to a conclusion and you will lose the house. Foreclosure may turn out to be a successful conclusion for you as well, depending on your situation.

If you are wondering whether strategic default is right for your underwater mortgage, my Strategic Mortgage Default System provides a clear, concise, and comprehensive process that will help you make the decision that is best for your unique situation.

Paul Stevenson

Strategic default is the financial decision to “walk away” from your underwater mortgage, even if you have the money to continue paying it. Many homeowners and investors are taking this step right now, and even more are considering it.

The term “walking away” makes it sound simple. Unfortunately, strategic default is anything but simple, and it is definitely not without risk.

Many (but not all[i]) mortgages dictate that if you default and the bank does not receive the full amount owed, you are liable for the amount of the deficiency (shortfall). If the property is underwater, you can be certain that there WILL be a deficiency.

For example, say you walk away on a $200,000 mortgage balance and the bank forecloses. If it then sells the property for $125,000, you still owe $75,000 – and in many cases the bank could pursue you in a lawsuit for payment of this deficiency.

The reality is that in the current real estate collapse such lawsuits do not appear to be happening very often, because the banks – and the courts – are so overwhelmed with underwater mortgage cases already. There simply is not enough bandwidth for banks to “go after” everyone who walks away.

The Goal of Strategic Default

As I discuss in my Strategic Mortgage Default System, if you choose strategic default, your goal is twofold: you want to dispose of the underwater property while at the same time protecting your other assets from being pursued by the bank to cover the deficiency.

In this two part objective, walking away and disposing of the property is the easy part – whether it is a short sale, a deed in lieu of foreclosure, or a foreclosure, you CAN get rid of the property.

The hard part is evaluating the risk to your other assets, and that is where you must clearly evaluate the entire situation you face. While it is certainly possible that a snap decision to stop paying and walk away could work out in your favor, if you have other assets to worry about, it pays to be as careful and rational as you can in making the decision for strategic default.

The Risk and Reward of Strategic Default

Borrowers who choose strategic default are effectively making a bet on the willingness of the bank to sue them for deficiency. They are betting that the bank would rather get the bad loan off the books, get as much cash as they can to cover it, and then be done with the borrower. A well-prepared strategic defaulter is likely evaluating the decision on whether to make the bet based on a number of questions, including:

• How important is disposing of this property to my financial future? And to my emotional future? (If the situation is causing me major emotional distress, which it is for so many.)

 

• Do I have a lot of other assets, making me look like an attractive target for the bank to single out and pursue for a deficiency judgment?

 

• How big is the mortgage and how far underwater am I? i.e., does the size of the bank’s expected loss make me a “big fish” in their loan portfolio and worth pursuing for a deficiency judgment, or am I small enough not to be worth their time and legal expense?

 

• How bad is the real estate market in my area? Are the courts already so jammed with foreclosure and deficiency cases that the bank realizes it will be years and a lot of legal bills before they even have a chance to get a deficiency judgment against me?

 

• Can I make a good hardship case for why I am walking away, thus either convincing the bank to simply let me go, or at least making it realize that a sympathetic court is likely to rule in my favor against “the big bad bank” if they pursue me?

If you are wondering whether strategic default is right for your underwater mortgage, my Strategic Mortgage Default System provides a clear, concise, and comprehensive process that will help you make the decision that is best for your unique situation.

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[i] If your mortgage is in “non-recourse” state, you may not be liable for a deficiency.

It seems like every time I turn around I see or hear yet another commentator discussing how Strategic Default for their underwater mortgages is immoral.  Furthermore, the growing trend of Strategic Default is deemed a sure sign that the apocalypse has finally arrived in our society.

There are of course other voices out there, including me, who are explaining things a different way, with the intent not to “stick it to the banks by encouraging people to walk away from their mortgages,” but instead to clarify the options for millions of Americans who are in fairly desperate situations that threaten their financial futures.

This work is necessary, because there has long been an asymmetry of information – the banks do not go out of their way to help underwater homeowners understand clearly and calmly the solutions that may be available to them, along with the risks and rewards involved.  Furthermore, in the current crisis, by many accounts, the banks have not been overly helpful (or speedy) in implementing the government-created mortgage modification programs that are designed to help these homeowners.

Who is Right?

Unfortunately it’s not that simple, because it’s not really a matter of right and wrong.  It’s a matter of perspective.  If your perspective is the one that has long been propagated by the banks and the government, then you believe that you absolutely have a moral responsibility to pay your mortgage, no matter what.  This long-held popular perspective effectively says that you have a responsibility that goes beyond the legal and financial agreement (the mortgage) that you signed with the bank.

I’m not saying this perspective is correct, I’m merely pointing out that this “additional layer of responsibility” has been present in most people’s minds for years.  And it’s in the banking industry’s best interests to keep it there.  Perhaps we could refer to it as a “Morality Premium” that has been applied to mortgages, though I cannot see any rational financial basis for it.

An analogy for the Morality Premium can be seen in the risk premium of, say, equity over debt.  This equity risk premium is based on the rational financial principle of risk vs. reward – generally speaking equity is more risky than debt, so equity holders must be compensated at a premium in return for accepting this excess risk.

Has the bank somehow done mortgage borrowers a favor, taking on excess risk beyond what it should have based purely on the financial facts of the transaction? If so, then the bank should expect to be compensated for this excess risk, which is where the hypothetical Morality Premium would come in.  It seems odd that banks and other lenders – arguably the most meticulous businesses in the world – would leave the collection of this premium to depend on borrowers’ morality, rather than putting it into the extensive legal agreements that are required to complete a mortgage transaction.

We all know this isn’t the case. Banks evaluate the transaction in a completely rational manner and decide whether or not to enter into the mortgage, and what terms to require, without the thought of doing anyone any favors.  In other words, they act exactly as they are required to act in order to uphold their fiduciary responsibility to their shareholders.

What Should the Borrowers Be Doing?

If the lenders are upholding their responsibility to their shareholders by extracting the most they can out of every mortgage transaction, then to whom is the borrower responsible?

The borrower is responsible to HIS SHAREHOLDERS – namely, himself and his family members, who all hope to have a financial future that is as solid as possible, within the confines of the law.  In light of this, how is it that the borrower should be required to take on the extra moral responsibility to pay his mortgage, no matter what, when he isn’t being compensated for taking on this excess risk to his shareholders’ well being?

So What’s the Real Story?

The bottom line is that you do not have a moral obligation to pay your mortgage.  You entered into an arms-length transaction with your lender in which both of you had competing interests and thus spelled out your obligations in a clear, signed contract. Unless the contract states that you have a “moral obligation to pay,” then it’s plain and simple – you don’t.

When you borrowed the money to buy the property, you entered into a business transaction. The lender evaluated the risks and concluded that it was a risk worth taking. For its protection, the lender also required you to pledge the house as collateral, as well as any equity you had in the house. The contract spelled out that if you don’t pay, the lender has the right to take the property and sell it before you get any of your equity back – if there were any equity left, which of course there is not if you’re underwater. The lender would not have loaned you the money if it had not concluded that doing so was a smart business decision. Your decision to enter into the transaction was also a business decision.

You decided to borrow the money and put at risk the property, your equity, and your credit rating. It’s obvious now, in retrospect, that both you and the lender made a bad decision. At this point the contract spells out what happens if you stop paying: the lender gets the property. If the lender intended for you to have a “moral obligation to pay,” it would have specified that in the contract.

While you may not think in terms of contracts and the terms for breaking them, I can assure that banks and all other large companies do.  As such, large companies make the business decision to break contracts EVERY DAY.  In this economic crisis, there have been many reports of large, profitable, cash-rich companies defaulting on multi-billion dollar property mortgages to large consortiums of banks – just because the housing projects they had mortgaged were far underwater, and they decided that it did not make business sense to continue paying.  So the contract took over and dictated that the properties went back to the bank – and the companies walked away.  And guess what?  Those same banks will probably give those same companies mortgages again in the future – because it’s just business.

Where Does That Leave Underwater Homeowners?

It seems quite clear, then, that propagating the idea of the “Morality Premium” is the banks’ way of encouraging homeowners to do something that is not necessarily in those homeowners’ best interest, while lenders are doing what they have always done – maximizing profits without regard for questions of morality or social responsibility.

If you are an underwater homeowner, you are in a position where you have to make the best financial decision you can for the sake of yourself and your family.  No one wants to default on their debts, but at the same time, no one wants their children to be without food or shelter.  These are difficult times that require difficult decisions.

Morality aside, there are other factors to consider.  These include the economic and emotional costs of giving up your home and moving, the worry about the social stigma associated with defaulting, and the potential damage to your credit rating. Still, the sum of all these costs might turn out to be much less than what it would cost you – both emotionally and financially – to pay off your underwater mortgage.

There is No Guaranteed Free Lunch for Those Who Walk Away

The lack of a moral obligation to pay your mortgage does not necessarily mean that walking away is the right move for you. That depends on a number of factors, including the state in which you live as well as many other aspects of your personal and financial situation.

In many states, if you do not pay the mortgage in full, either through a foreclosure or some other form of walking away, the bank may be able to pursue a deficiency judgment against you.  If successful, you may be liable to pay the difference between what you owe and the market value of the property the bank took back.  The main idea for strategic defaulters is that the banks are not likely to pursue such a judgment, because they simply do not have the bandwidth due to the enormous volume of bad loans on their books.  Thus far in the crisis, it seems that this has been a reasonable assumption to make.

Beyond the worry about a deficiency judgment, there may also be significant tax implications if the bank does forgive the balance of your mortgage.  And of course your credit score is certain to suffer a significant drop.  So clearly, if you walk away, there is no guarantee that you will be getting away “scot free.”

Strategic Default is a complex issue that must be understood thoroughly before you enter into it.  However, if your analysis determines that it is not in your financial best interest to continue paying your mortgage, then I urge you not to let false beliefs about moral obligation put you and your family in further financial peril.

If you want help learning more about Strategic Default, and whether or not it might be the right decision for your underwater mortgage, my Strategic Mortgage Default System will give you a clear, concise, and comprehensive picture of what your best option is.

Paul Stevenson