Strategic foreclosure is the latest buzzword circulating throughout the real estate industry. The mortgage crisis left millions of homeowners owing more than their home is worth. Experts predict housing prices will further decline and set off a frenzy of homeowners who voluntarily enter into foreclosure.
The strategic foreclosure trend began with celebrities and the wealthy defaulting on loan payments in attempt to force lenders into negotiation. Banks aren't willing to negotiate loan terms and certainly won't write off declining property values when homeowners can afford to make payments. The only way to get their attention is to stop paying mortgage payments.
Entering into planned loan default is often compared to a gambling bluff. Homeowners who voluntarily default do so in hopes of negotiating a short sale or principal loan reduction. However, banks are not required to oblige with requests, so those who use this strategy must plan ahead if property is repossessed.
The majority of homeowners entering into strategic foreclosure is capable of making payments and has impeccable credit. Additionally, homeowners typically use this strategy for investment property, not their personal residence.
When foreclosure is reported to credit bureaus, homeowners can expect a minimum 100 point reduction in FICO scores. Those with excellent credit can recover from score decline, but the reduction can be devastating to those with medium to low scores.
Interest rates are determined based on FICO scores. The higher the score, the lower rate of interest. When people lose real estate to foreclosure they usually can't obtain another mortgage note for a few years. If they lose excellent credit status they may have to pay higher insurance premiums or experience reduced credit limits.
Homeowners who lose their home to foreclosure may find it difficult to locate a landlord willing to rent unless tenants provide first and last months' rent and security deposit. Before voluntarily defaulting on mortgage installments take time to calculate the true costs.
Several banks hold homeowners responsible for the monetary difference between the loan balance and sale price. If homeowners don't pay the banks can obtain deficiency judgments and engage in collection actions including garnishing wages and repossessing property.
Deficiency judgments are reported to credit bureaus and can further reduce FICO scores. Worse yet, judgments are reflected on reports up to 10 years after the debt has been paid. Considering property values have declined by as much in some markets, deficiency judgments can amount to thousands of dollars and impact credit-worthiness for years to come.
If you're successful in using strategic foreclosure to obtain real estate short sales, deed in lieu of foreclosure, or principal reduction of mortgage balance it's important to consult with a tax attorney. The Mortgage Forgiveness Debt Relief Act allows homeowners to claim special tax relief and exclude the amount of debt forgiven on personal tax returns.
While strategic default can release homeowners from underwater mortgages, many people view it as a moral dilemma. These homeowners understood that investing in real estate carried risks and feel an ethical obligation to make good on their promise to pay. They prefer to maintain their excellent credit status and weather out the storm until the market turns around.
Only you can decide if strategic foreclosure is a good option for you. Take time to weigh the pros and cons and consult with professionals to understand tax and credit ramifications. If you're able to fulfill mortgage payment obligations you'll have to determine if this strategy falls inside or outside your moral compass.
We invite you to learn other options to avoid foreclosure, along with tips for obtaining short sale and loan modification approval in our real estate article library. Take a moment to subscribe to our mailing list to receive notification when new articles are published.