By Beth Kassab, The Orlando Sentinel, Fla.
Jun. 2—For underwater homeowners who think they’ve found a solution to their predicament—stop paying the mortgage and remain in the house until they are forced out by foreclosure—the consequences of such a decision are not as simple as they may seem.
The short-term advantages of a “strategic default” are tempting. The notion of continuing to pay far more than a house is valued at today, or owing more than you think it will be worth five or even 10 years from now, is enough to prompt many people to walk away.
The foreclosure process can be a long one. In many cases, people who decide to stop paying can reap the benefits of free housing—or in the case of investment homes, a free and clear income stream in the form of rent—for more than a year before they are evicted from the property.
Some borrowers see strategic default as a temporary free ride that allows them to sock away savings or make certain the rest of their financial lives are in order.
And many seem willing to accept that they’ll emerge with a damaged credit history because of it.
But consider this before you walk:
The biggest wild card for borrowers is whether banks will go after them for the remainder of the unpaid loan or what’s known in the legal world as a “deficiency judgment.” A foreclosure or even a short sale doesn’t necessarily mean that your debt is forgiven.
Florida law allows lenders to go after certain other assets that belong to a borrower to make good on the unpaid loan.
It’s true that many lenders haven’t taken the time or spent the money to pursue borrowers in this way as foreclosure rates have soared in recent years. In fact, attorneys who help borrowers through the foreclosure process say lenders often end up waiving their right to chase the unpaid debt as part of the resolution to foreclosure cases.
But that could change if banks find that more and more people in foreclosure have the means to pay.
“It is my belief that banks will begin to sell off the money they are owed to collection companies in the coming years that will, in turn, aggressively pursue collection efforts,” said Matt Englett of Kaufman Englett & Lynd, a law firm that specializes in foreclosure cases. “There will be a whole new cottage industry created as a result of this.”
Lenders have up to five years to seek a deficiency judgment and 20 years to collect.
What’s more, if a borrower decides that he doesn’t want to land in foreclosure and tries instead to negotiate a loan modification, the lender will typically still seek any missed mortgage payments and figure them into the new terms of the loan.
Borrowers also must be wary of potential tax penalties.
A 2007 rule change by Congress relieves borrowers who occupied a foreclosed-upon home as a primary residence of any tax liability on unpaid debt. However, borrowers with investment properties in foreclosure could owe taxes on the unpaid portion of the loan.
And the final question: Just how low will a strategic defaulter’s credit score go?
The short answer is that foreclosure will lower a score by 130 to 140 points for consumers who otherwise have good credit, according to a spokesman for VantageScore Solutions, a consumer-credit-scoring model created by the big three credit-reporting companies.
A foreclosure remains on a credit report for seven years.
There’s likely more to it than just a number. When deciding whom to loan money to in the future, lenders could consider strategic defaulters a higher risk than someone who lost their home to foreclosure because of a job loss or other hardship.
A borrower who walks away once, they could very well reason, may be willing to do it again.
Beth Kassab can be reached at email@example.com or 407-420-5448. Read her blog at OrlandoSentinel.com/thebottomline.
Read Beth Kassab’s previous columns “strategic defaults”:
May 19: Dumping mortgage: Strategic but moral?
May 21: Where’s relief for homeowners who played by the rules?
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