The History of Strategic Default
In this article, we will explore the concept of strategic default, a legal maneuver that gained prominence during the housing crisis of the 2010s. During that period, many homes were worth significantly less than the outstanding mortgage balances, often burdened by second or even third mortgages. As the subprime housing bubble burst, a wave of foreclosures swept the nation. With each foreclosure that went to auction, surrounding property values dropped, fueling the contagion that worsened the housing crisis.
What is Strategic Default?
According to Black’s Law Dictionary, a default occurs when there is a failure to perform a contractual or legal duty, such as fulfilling an agreement, promise, or obligation. In the context of a mortgage, which is a binding contract, default means the borrower has not made payments as agreed. Technically, you are in default after missing just one payment. Importantly, a bank is not obligated to accept payments once a default has occurred.
The term “strategic” refers to a deliberate choice made by the borrower to stop making mortgage payments. This decision can stem from various factors, including:
- Underwater Mortgage: The property is worth significantly less than the outstanding mortgage balance, making it unlikely to regain equity.
- Unaffordable Property Taxes: Property taxes have increased to the point where they are no longer affordable.
- Leverage for Renegotiation: The borrower believes they can leverage the default to renegotiate more favorable loan terms with the lender.
- Unfair HOA/Condo Bylaws: The homeowners or condo association has enacted untenable or unfair bylaws, making ownership undesirable.
- Job Loss or Income Reduction: A significant loss of income due to job loss, reduced work hours, or business decline makes it impossible to continue making payments.
- High Interest Rates: The mortgage has a high interest rate that makes monthly payments unmanageable, with no option to refinance at a lower rate.
- Unexpected Major Expenses: Unforeseen expenses such as medical bills or emergency repairs have depleted the borrower’s savings, leaving no funds for mortgage payments.
- Investment Property Depreciation: The borrower owns an investment property that has significantly depreciated in value, making it no longer a profitable investment.
- Relocation or Divorce: The borrower needs to relocate for work or is going through a divorce, and the property can’t be sold for enough to cover the mortgage balance.
- Unstable Neighborhood: Crime rates or environmental issues have made the neighborhood undesirable, reducing property values and making continued ownership unappealing.
These are all reasons a borrower might make the strategic decision to default on their mortgage. While this strategy carries significant risks and consequences, it can also offer potential benefits in certain circumstances.
Benefits of Strategic Default
- Save Money: By ceasing mortgage payments, borrowers can immediately free up cash for other financial needs or savings.
- Retain Possession: Depending on the skill of your foreclosure defense attorney and the legal defenses available, you may be able to remain in the property for months or even years during the foreclosure process.
- Rental Income: There is the potential to rent out the property during the foreclosure process, generating income even after defaulting on the mortgage.
Drawbacks of Strategic Default
- Severe Credit Score Damage: Defaulting on your mortgage will significantly damage your credit score, making it more difficult to obtain future loans or credit. In my experience, one missed mortgage payment can decrease an otherwise clean credit score by up to 100 points. This is because mortgages typically play a substantial role in boosting a credit score. If you have a performing mortgage with no missed payments, your score is likely to be over 800. Therefore, a single missed payment can cause a severe drop, usually by up to 100 points.
- Inevitable Foreclosure and Forced Move-Out: Strategic default will eventually lead to foreclosure, resulting in the loss of the property and a forced move-out.
- Increased Fees and Debt: With each missed mortgage payment, late fees, interest, and other miscellaneous costs accrue, such as property inspection fees and real estate taxes. Once foreclosure proceedings begin, additional legal costs and attorney’s fees are added. If your property has any equity, these expenses will reduce the amount you might receive from a traditional sale. This is why strategic default is generally advisable only when your property is underwater; otherwise, you risk significant financial loss by playing a high-stakes game of chicken with the bank.
- Potential for Deficiency Judgment: You may still be liable for any remaining debt after the property is sold, known as a deficiency judgment. However, pursuing a consent foreclosure could eliminate the possibility of a deficiency.
Important Considerations
Strategic default is a complex legal matter. Always consult with a foreclosure defense attorney to fully understand your options and protect your rights.
- Chapter 7 Bankruptcy: Filing for Chapter 7 bankruptcy can eliminate personal liability for any remaining debt after foreclosure, but it comes with its own set of consequences that must be carefully weighed.
- Consent Foreclosure: A consent foreclosure may offer a quicker resolution but could limit your time in the home.
Ultimately, strategic default is a high-risk strategy with potentially severe consequences. It’s essential to carefully consider all the drawbacks and consult with a legal professional before making any decisions.
Schedule a consultation to speak with Steven J. Grace regarding your legal options regarding strategic default.
