Sometimes a property is so far underwater that it could take years before the home regains all of its value. If that happens, borrowers sometimes choose to stop making payments , even if they could afford to stay current, simply because the home has become a bad investment. This decision is known as a "strategic default," which is also sometimes called "voluntary foreclosure" or "walking away. Generally, the term "strategic default" implies a different situation than a homeowner who's struggling financially and can't afford to keep paying the mortgage payments.
With a strategic default, the borrower does the math and makes a business decision to voluntarily stop making payments, even if it's within their ability to stay current on the loan.
After the homeowner voluntarily stops paying, the bank forecloses. If you're contemplating a strategic default, you should know the consequences and consider them as part of your decision-making process.
In a foreclosure, the borrower's total debt might exceed the foreclosure sale price. The difference between the sale price and the total debt is called a "deficiency. In some states, the bank can seek a personal judgment called a " deficiency judgment " against the borrower to recover the deficiency.
With a strategic default, you might be liable for a deficiency judgment after the foreclosure, depending on your state's laws. Some states, like California , for example, have anti-deficiency laws. If a state has anti-deficiency laws, a foreclosing bank can't seek a deficiency judgment under specific circumstances.
Most homeowners in California won't face a deficiency judgment after a foreclosure. Other states, like Florida , for example, do allow deficiency judgments.
If you walk away from your home, you might have trouble getting a new mortgage loan. Fannie Mae , for instance, has stated that strategic defaulters won't be eligible for a Fannie Mae-backed mortgage for seven years from the date of the foreclosure.
Fannie Mae also stated that it will take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments. A foreclosure won't ruin your credit forever, but it will have a considerable impact on your score, as well as your ability to obtain another mortgage for a while.
Also, a foreclosure could impact your ability to get other forms of credit, like a car loan, and affect the interest rate you receive as well. If you plan on renting a house or apartment after a strategic default, bear in mind that it's standard for landlords to review your credit report when deciding whether to rent to you. The rental market is competitive, and a landlord might be able to select a renter with better credit over you. While foreclosure has lost much of its social stigma, many employers routinely run credit checks on potential employees.
Because a foreclosure will appear on your credit report, it could cause issues for your job prospects. Of course, whether having a foreclosure on your credit report will affect your options depends on the employer and, to some extent, the reason for the foreclosure. For example, if you're applying to work at a telecommunications company, a foreclosure might not hurt your employment chances—especially if you can show extenuating circumstances, like you had serious medical issues that led to the default.
But if you're applying for a job in the financial services or banking industry, a bad credit report could very well affect your ability to get the job. The potential employer might think that if you couldn't manage your own money, you won't be able to handle someone else's competently.
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The pros and cons of a strategic default on a mortgage Published January Pros The most common reason for undertaking a strategic default is to escape what the borrower has come to see as a bad investment. Cons Instead of allowing you to save money, a strategic default may end up costing you. Alternatives A foreclosure is a drastic step to take, so homeowners considering a strategic default should think about other options as well. Next Article. Tax Resources. Real Estate Resources.
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A strategic default is not making payments on a loan on purpose, as opposed to wanting to pay the debt but not being able to. Although both practices have the same result -- not paying back the loan -- a strategic default is more than just semantics. Strategic default is a planned strategy some residential and commercial real estate investors use when they're in a situation that makes it more favorable to default on their mortgage than pay it.
What usually prompts investors to choose a strategic default strategy is if they owe more on the property than what it's worth, a scenario known as being underwater on the loan. When that happens, many investors choose to stop making payments and let a foreclosure happen.
Other terms for strategic defaults are "walking away," "strategic foreclosure," or "voluntary foreclosure.
If an investor is underwater on a loan and having financial difficulties as well, the decision to strategically default becomes a bit easier. Not all investors who find themselves underwater on a loan choose strategic default. Some continue to pay the loan, confident the property will be worth more in the future.
What currently appears to be a bad investment could prove to be a good one after enough time goes by to let the investment appreciate. Plus, by not defaulting, the investor keeps their good credit, allowing them to make further investments if they like. Banks and other lenders don't like strategic defaults, and they have another name for this practice.
They call the borrowers " walkaways " and the act of what they're doing " jingle mail ," a reference to the borrower mailing the lender keys to the property instead of the mortgage payment. Because of financial fallout from the coronavirus pandemic , global corporate defaults reached an year high , and the United States had the most: corporate defaults in
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