In the previous articles we introduced this ‘Now What Do I Do?’ series, and discussed Option 1 – Sit Tight in the first article. Then we discussed some options you might pursue if you didn’t have the income or the savings to be able to continue to make your mortgage payment: Option 2 – Loan Modification, Option 3 – Short Sale, and Option 4 – Deed in Lieu of Foreclosure.
In this post we’ll talk about a fifth option that you may want to think about even if you are financially capable of maintaining your payments. Option means you have a choice. This option is called Strategic Default or, more casually, ‘walking away’ or ’sending in the keys’. You are ‘underwater’, and you owe more on the mortgage than the house is worth in the current market. The essence of Strategic Default is that although you may be capable of continuing to make the mortgage payments, and are therefore not eligible for a Short Sale or Deed in Lieu settlement from your lender, you may decide for any of a variety of reasons that you should not continue making the payments, and that you will simply return your home to the bank and let them foreclose and re-possess it or sell it at the foreclosure auction.
There are a number of key factors for you to consider in this thought process, none trivial, and all laid out many times in the press over the past couple of years. Five of the main ones are summarized here:
- Your circumstances may have changed, and this house may no longer be appropriate for you – in size, in expense, in location, etc; perhaps no longer appropriate to the degree that you would consider bearing a fair amount of pain to get out of the mortgage, move out of the house, and start over.
- A foreclosure would cause a significant negative impact on your credit score, and your ability to buy another house later, or a car, etc; it could also have a negative impact on your ability to get your next job, as employers are starting starting to use credit records as a job qualification
- It is considered unethical and immoral to not pay your debts; however, it is not illegal. The agreement you signed has a specific legal process,called foreclosure, for canceling it. The lender, as well as you, willingly entered into both sides of the agreement, with the house as the secured asset.
- You may not have been prudent in how much you borrowed, but you didn’t cause the financial debacle we are now in, nor did you personally cause the value of your house to drop to the degree it has. This is a bit like force majeure logic
- You have some obligation to consider the impact that staying in the home and continuing to make the payments has on your family’s well-being and financial future – relocating can be a major disruption, but being deeply underwater financially can be very stressful and unproductive.
Please keep in mind, again, that I am not a lawyer or accountant or licensed financial planner, and I cannot tell you all the ins and outs and consequences of this kind of action in your particular situation. If you have a second mortgage, or certain other kinds of liens, you particularly want to consult a lawyer, and perhaps your accountant as well, before making this kind of decision. Not all types of liens are wiped out by foreclosure.
If you would like a little more description of the foreclosure process, please see the next and last post in this series – Option 6 – Foreclosure. If you choose, for your own good and well-thought out reasons, to go down the Strategic Default path, then you want to manage the foreclosure process in the most businesslike and least painful way possible.
So there is lots to think about, and the stakes are not trivial. But the evidence is that the further people are underwater on their mortgage, the more likely they are to make the Strategic Default decision. Here is a chart from a presentation at Moody’s Fall 2009 Economic Outlook Conference – in this chart, from page 10 of the presentation, the left axis is CLTV – Current Loan to Value Ratio. A loan to value ratio greater than 100 means you are underwater. Note how the delinquency rate, and implied default rate, starts climbing sharply for CLTV rates over 105%.