What is a Strategic Default and When is it an Appropriate
Decision?
By Charles P. Castellon, Esq.
CPC Law
© 2015, All Rights Reserved
For many homeowners, a plummeting housing market
has transformed a previously prudent investment into an oppressive financial
burden. Engaging in a strategic mortgage default with the help of a
foreclosure defense attorney may be one of your best options for controlling
damage to your credit. If you’ve found yourself in a tough financial
situation with your mortgage lender, then consider whether or not strategic default is a
feasible option for you.
·
What is a Strategic Default?
A
strategic default occurs when a borrower who is able to pay their mortgage
chooses to stop because a property’s value has dropped significantly below the
mortgage debt owed on it. Because strategic defaulters (as opposed to seriously
financially distressed borrowers) are more likely to have higher income and
assets, the decision to stop the payments should include asset protection
considerations and strategic planning.
·
What are its Consequences?
As
with any other foreclosure, the direct consequences of a strategic default are
fundamentally the same. It’s important to understand that the
strategic default decision is not the end of the discussion, but rather, the
beginning. The decision to discontinue payments should lead to the next
question—“now what?” A borrower may simply give up and allow the lender
to foreclose, but this is a terrible idea. In most cases, attempting a
short sale of the property will be the best damage control option.
Although
getting short sale approval is often more challenging for the strategic
defaulter due to the lack of “hardship” the lender expects to see, the borrower
should not consider this a “zero sum game.” There does not need to be an
absolute winner or loser in this process between the borrower and lender.
Quite often, strategic defaulting borrowers will agree to bring money to the
closing table in exchange for a release from a much greater mortgage debt and
an exit from a bad real estate investment. The
borrower should consider that the credit damage resulting from a short sale
could be overcome in as little as one and a half to two years.
· The Moral Question
Many
borrowers who retain the ability to pay the mortgage resist the idea of
strategic default because of moral considerations. They adhere to
traditional values of honor and integrity and the notion that signing a
“promissory note” means a promise to pay. This moral question deserves a
detailed and thoughtful reply. A good place to start is by reading the
moral discussion in University of Arizona Law Professor Brent White’s classic article,
Underwater and Not Walking Away: Shame,
Fear and the Social Management of the Housing Crisis. In essence, a
strategic default is not an avoidance of the consequences of the mortgage; it
is the acceptance of them. A borrower signs a promissory note, which is a
legal contract to repay a loan. The note is secured by a mortgage, which
is the borrower’s consent to allow the lender to take title to the property
upon failure to repay the note. The probability of defaulting on the note
is factored into the deal through the mortgage. Otherwise, the
lender could simply lend the money unsecured, as with credit card debt.
For
the lender, as with any other corporation, the bottom line is the bottom
line. It’s a business transaction and the parties in any business deal
are expected to act in ways to further their own self-interests. It is
hypocritical and unfair to expect an individual borrower to sacrifice his own
self interest for the benefit of the other party in the deal—the lender.
There are endless examples of naked self interest in the corporate world
trumping moral considerations, including the noteworthy instance where Morgan
Stanley strategically defaulted and walked away from its obligation to pay on
several upside down properties it owned. In the business world, we eat
our mistakes. Unfortunately, the control of our government by Wall Street
and their partners in crime in the lending industry have created a world of
socialized losses and individualized gains, as the “too big to fail” federal
bailouts have sadly demonstrated.
If
lenders recklessly issued mortgages on the faulty premise of continuing rising
home values to provide their “cushion” and they were tragically wrong, it
should not fall on the borrower (the less sophisticated party in the deal who
had no choice but to accept all the lender’s terms or not do the deal) to bear
the burden of the housing market collapse. This brief discussion does not
do justice to the moral question, but it’s a start. Any borrower
considering a strategic default should contact the law firm of CPC Law to
discuss all the ramifications, including the moral issue and create a strategic
game plan.