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.

One of the key issues that will determine your potential risk in a strategic default is whether your underwater mortgage is a “recourse” or “non-recourse” loan.  In some states mortgage loans are recourse, meaning that you are personally liable for what is owed on the mortgage if you don’t pay.  In states with non-recourse mortgage loans, you are only personally liable for the property’s value at the time the loan is repaid or the property is returned to the lender.

In other words, in a non-recourse state, borrowers are not held personally liable for more than the home’s value at the time that the bank takes possession of the property in a foreclosure.  The lender’s only remedy is to recoup some of its loss through selling the foreclosed property.  The lender can’t sue the borrower for funds beyond what it is able to obtain through the foreclosure.  If the foreclosure sale does not generate enough money to satisfy the loan (and with an underwater loan, it will not), the lender simply has to accept the loss of the remaining amount – known as the deficiency.

In a recourse state the lender in many cases can sue the homeowner for any deficiency after the property has been sold at auction.  If you are in a recourse state, this is the major risk you potentially face in a strategic default.

There are of course details that you must be clear on for your particular situation.  Each non-recourse state has its own statutes that prohibit lenders from seeking judgments for deficiencies, and there are a few cases in which these anti-deficiency statues allow lenders to collect a limited amount of money from the borrower. 

Also, there are some non-recourse states – such as California – in which non-recourse laws apply only to “purchase money” loans, meaning original home loans that are used for the actual purchase of the property. Almost all HELOCs and home equity loans are considered recourse loans, so if you took out a second loan, the lender probably has the ability to sue you in an attempt to attempt to recover losses.  But even this has exceptions, such as in some cases where the second mortgage lender forces the foreclosure.

My goal in this article is to provide you with a general idea of what you are facing in terms of the lender’s ability to sue you to recoup losses beyond the value of the property.  There is quite a bit of variation in the foreclosure laws and procedures from state to state, and these laws change from time to time as well.  The current details of your situation are best confirmed by an attorney in your state.

The general idea behind strategic default is to rid yourself of the liability of an underwater mortgage.  Hence you must always keep in mind the question of what legal and financial means are available to the bank – if any – to pursue you for the deficiency that is certain to exist.

In order to decide whether strategic default is right for your underwater mortgage, you must first be clear on whether or not you face recourse from your lender.  Once you know where you stand, you can evaluate the rest of the variables.

This entry was posted on Tuesday, February 1st, 2011 at 6:40 am and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.