Dangers of Strategic Defaults
With so many Americans struggling to make mortgage payments or simply falling further and further behind, it’s no wonder some homeowners are looking into strategic defaults. In fact, there are even companies now who offer the legal services to theoretically make strategic defaults “safe” for your financial future. Are they really safe, though?
What is a strategic default?
Strategic default (also known as a strategic walkaway) is the practice where a homeowner stops paying their mortgage and defaults on the loan. Strategic default can actually be used on any debt, but is mainly used to get out of a mortgage when a property is worth drastically less than what is owed. As the borrower sees it, it’s pointless to keep paying on a mortgage when your home is worth much less than what you’re paying—in some cases, less than half of the mortgage owed.
In this sense, strategic default may seem like a really good idea. You’re paying your lender on a $100,000 mortgage for a home that’s only worth $50,000. Even if you paid the loan off and sold your home, you’d still never recoup most of the money spent. It seems like a waste—and it is, but there are other, better options to help you solve the problem rather than strategic default.
What are the dangers in strategic defaults?
First, you’re going to seriously damage your credit and your ability to borrow. While foreclosure stays on your credit report for up to 7 years, the weight it carries decreases year by year. You can also do things like paying off debts to improve your credit and reduce the impact more.
While some strategic default assistance companies report a strategic default may cost fewer points on your FICO credit scores, it doesn’t get removed from your credit report any sooner—almost all penalties, including loan defaults, stay on your credit for 7 years. In addition, new federal regulations targeted at stopping strategic defaults make you completely ineligible to get a home with a Fannie Mae backed mortgage for that full 7-year period. In some cases with a foreclosure, you can actually get a new mortgage in as little as 3 years.
Another danger comes with tax liability. Under the Mortgage Forgiveness Debt Relief Act of 2007, homeowners forced to foreclose on their homes are protected from having to pay federal taxes on the debt, although state taxes may still be applied. With a strategic default, you are not protected at all.
The biggest danger of strategic default is that your lender can actually pursue a delinquency judgment against you, so you may end up having to pay the debt back anyway or pay at least a portion of it. Imagine walking away from your home because you think it will improve your financial situation, only to get hit with a delinquency judgment. You still have the debt; you just don’t have a home to show for it.
There are better options than strategic default!
While the government is putting laws in place to crack down on strategic defaults, they’re also putting programs in place that offer much better alternatives. If your home is worth less than you owe, the Housing Affordability and Stability Plan (HASP) offers options to refinance and/or modify your mortgage.
In addition to the HASP options, the Hardest Hit Fund allows homeowners additional options to address extreme mortgage distress, including an option that allows you to adjust the principal of your mortgage to help ensure you’re only paying what your home is actually worth. The HHF even has assistance programs in some states to help pay your mortgage if you’re unemployed.
Your final option is foreclosure and although many people balk at the idea and assume strategic default would be better, in truth you can deal with a foreclosure on your credit report—it’s not the end of your financial world. With a foreclosure, you’re protecting yourself against tax liability and litigation from your lender. Your credit score will be impacted, but you can make a plan to rebuild your credit and have your finances back on track in less time than you think. Give us a call at 1-800-990-9838 to let us review your situation and provide information on the various options available.