In California and across the country, homeowners are doing what’s called “strategic defaulting” on their homes. This means that even though they can afford their mortgage payment, the borrower is so underwater on their home that they intentionally stop making payments and ultimately give their home back to the bank. Unlike many other states, a lender cannot go after the former homeowner for unresolved debt in California so they are able to make a clean break.
There are many situations in California where the borrower took a 0% down adjustable rate mortgage and have been paying primarily interest for the last few years. As it is, they have built no equity and “own” little to none of their home. In other situations, a homeowner who purchased, say, a million dollar home for example, finds that their home is now worth half as much. They will be lucky if their home is worth what they paid for it at the end of their 30-year loan.
Does it make sense for folks in these situations to walk away? Another question some critics are asking… Is it morally wrong for borrowers who can afford to continue paying their mortgages to strategically default? Let’s examine the reasons behind saying Yes or No to these questions.
First, does it make financial sense? Possibly, for the same reason it might make financial sense to declare bankruptcy if you find yourself with too much debt that you’ll never be able to pay for. A clean break from your home could make sense if it’s not worth what you paid for it and you’ve built no equity.
On the other hand, it means you’ll be a renter after you get evicted. This is almost a guarantee because it will become near impossible to obtain financing on a home, especially through Fannie Mae, for at least the next 7 years. Consider a situation where a borrower walks away from a $2,500/month mortgage payment and rents a similarly priced property. Over the next 7 years, they will have spent $210,000 or more on rent. Real estate values fluctuate so there would have been a chance that their home went up in value over the next 7 years. The chance of that happening is irrelevant as a renter.
Is strategic defaulting morally wrong? After all, you made a commitment to pay your lender. Plus, going into foreclosure negatively impacts the value of your neighbors’ homes who are still paying their mortgages. Some say that strategic defaulting is the reason why the housing crisis continues to get worse… but that’s a matter of opinion. On the other hand, is making a strategic financial move for yourself and your family a bad thing? Corporations make similar financial decisions to breach a contracts so why can’t individuals do the same?
If you’ve heard the buzz about strategic defaulting and are thinking it might be right for you, consider some alternatives before pursuing. Talk to your lender about loan modification or if a short selling your home is an option. Most importantly, before considering a strategic default, talk to your lawyer and accountant about the consequences. Make sure you have a plan that takes into account your property taxes and HOA dues if applicable, which you might still be responsible for even if you give your home back.
If you’re on the other side of a strategic default and are looking to buy a bank owned home for sale, check out our selection of REOs for sale in California or search all homes for sale in California.
What are your thoughts about strategic defaulting? Do you think it makes financial sense? Is it morally wrong? Leave us your thoughts in the comment section below.
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