Jane Schrodinger was aghast when she learned that she was $80,000 underwater on her “sad little condo” in Washington state. After all, she purchased the condo back in 2008, when prices were low and interest rates were attractive enough to make buying more sensible than renting. Smart move, right?
As we all so painfully learned, prices continued dropping until she ended up where she was – deep underwater on her mortgage. We can’t call Jane a “distressed” homeowner, though. Despite the fact that thoughts of her situation kept her up at night, she was perfectly capable of paying her mortgage every month.
She decided, however, to walk away from her obligation. Not only did Jane fully plan this walk-away, she chronicled the process in a series of blog posts.
Jane is one of 68 million Americans who see nothing wrong with walking away from their agreement with their lender. This is a process known as “strategic default” – a sanitized name for something that lenders call “jingle mail” (because they typically receive the house keys in the mail) and many others call downright wrong.
Strategic default is, simply, planning (that’s the strategic part) to walk away from the obligation one holds to pay as agreed on her mortgage loan. That’s the default part. It differs from economic default in that the homeowner has the money to pay her mortgage, she just decides that it’s more beneficial not to.
Studies show that there is a certain sub-set of the population that is more prone to strategic default than others. As one might expect, the list includes homeowners who have been denied a loan modification, those who perceive their lender as being evil or greedy, homeowners with previous defaults, homeowners under the age of 45, and males. Surprisingly, a rather substantial portion of strategic defaulters are high FICO scoring, high net worth individuals – the kind of buyers lenders love to lend to.
Should You Walk Away?
While this conversation was more pertinent two years ago, an estimated 7 million Americans remained underwater on their mortgages at the end of 2012. That number is down 4 million from 2011. Many homeowners who could afford to stay in their homes decided to ride out the market and are now beginning to see the light at the end of the tunnel.
If you’re one of those who can pay the mortgage and you’re considering a strategic default, you may want to think about the following:
Your credit score – Jane had a near-perfect credit score when she made the decision to walk away from her loan. During the process she worked diligently to protect her score by obtaining new credit cards, using them and paying on time. That said, the American Bankers Association claims that a foreclosure will impact your FICO score by 100 to 400 points. Furthermore, the public affairs director for FICO, Craig Watts, says that FICO looks at foreclosure as “one of the stronger predictors of future credit risk.”
Buying again – Jane is fortunate that her husband Cory wasn’t a co-borrower on the condo. She happily walked away from the home knowing that they could and would buy again shortly after the default. If you aren’t in a similar situation, you may want to consider that you will be ineligible for a Fannie Mae mortgage for the next seven years. The ABA suggests that you kiss off your chances of buying another home for the next three to seven years.
Tax liability – One of Jane’s biggest concerns was the possible rescission of the Mortgage Forgiveness Debt Relief Act at the beginning of 2013. While congress has decided to extend the act, you may still be liable for state taxes on the amount of debt forgiven in the foreclosure.
Deficiency judgment – When you walk away from your mortgage obligation and the lender forecloses on the home, it will determine the difference between the amount of money you still owe on the home and the amount it was able to realize at auction or sale.
This amount is known as the “deficiency,” and, depending on which state you’re in, the lender may go to court to obtain a deficiency judgment against you. Not only will the amount of deficiency be included in this judgment, but you could also be on the hook for attorney’s fees and the costs incurred by the lender during the sale of the home. In some states, according to Forbes, lenders may also add penalties and interests to the amount owed.
Phantom title – Strategically defaulting homeowners who have lived rent- free for the period of time leading up to the lender deciding to foreclose typically decide to abandon the house when they receive notification that the lender has the foreclosure judgment and is moving toward auctioning the property. Off they go into their new life, pockets full of unpaid mortgage money and blissfully unaware of what is known as the “phantom title.”
Should the bank decide, for any number of reasons, to cancel the auction, title remains with the homeowner. Although the lender is required to notify the borrower that the house was not sold, most strategic defaulters don’t leave a forwarding address and, thus, fail to receive the notification.
What this means is that while you may think you’re finished with the house, it remains your legal responsibility. Phantom title holders may find their wages garnished or their tax refunds seized to reimburse municipalities for moneys spent having to maintain the house or complete repairs due to vandalism. According to Reuters senior correspondent Michelle Conlin, some of these items include “graffiti-scrubbing services, demolition crews, trash removal, gutter repair, exterior cleaning and lawn clipping.”
If the lender can find you, you just might get a court summons or the threat of a jail sentence.
Current housing market – Finally, before you decide to walk away, take a look at current housing market trends. There is a lot of optimism out there, according to the results of Fannie Mae’s December National Housing Survey, especially when it comes to mortgage rates and home prices.
“The highest share of consumers in the survey’s two-and-a-half-year history expect home prices to increase in the next 12 months,” said Doug Duncan, senior vice president and chief economist of Fannie Mae.
Anecdotal evidence from real estate agents across the country shows that buyer enthusiasm is high while housing inventory is low: the perfect setup for a healthy rise in home prices.
In a nutshell, if you are considering a strategic default, think long and hard on the old motivational quote: “Don’t quit before the miracle.”