What is a Strategic Default?
Strategic default is when a homeowner may be able to afford their payment and may not qualify for a short sale or modification and simply stops making the payments. The motivation is simple, they owe far more than the home is worth and decide to stop making payments until the home is foreclosed.
What are the benefits?
In Arizona, the foreclosure process may take up to a year or longer before it is final. During this time the homeowner is not making a mortgage payment and the savings may add up to a substantial amount and go along way in providing future housing at a far more affordable price.
What are the risks?
Generally speaking, if you choose to strategically default, some of the risks include:
- Impaired Credit - A default may stay on your credit report for many years and jeopordize your ability to borrow. Credit card companies or revolving accounts may reduce limits or cancel accounts.
- Deficiency Risks - Depending on which state you live in, there are varying deficiency risks associated with walking away from your mortgage. Even though Arizona has anti-deficiency laws in place, you may still have liability depending on issues such as; Did you refinance and take cash out? Is your mortgage the original purchase money mortgage you obtained when you bought the home? Is the property your primary residence? These are just a few of the several issues to be considered. If you are planning a strategic default, we strongly recommend you speak with a real estate lawyer and do not rely on advice from friends, family, or neighbors.
- Tax Consequences - Again, depending on your specific situation, there can be a significant tax liability and you should consult a tax professional regarding this matter.
The morality issue!
One of the statements we hear regularly is "I signed the contract and I have a moral obligation to uphold my end of the deal."
Many will argue that every mortgage loan agreement includes default and foreclosure as a possible outcome and outlines the remedies. In short, if you stop making the payments, you're not breaching the contract, because default and foreclosure are valid means of fulfilling the contract.
Brent White, an associate professor at University of Arizona's James E. Rogers College of Law, makes the argument that underwater homeowners, are being manipulated into picking up the tab for a real estate crash that borrowers and lenders created equally. "Im all for a society where people must take personal responsibility, but that should also apply to the banks and financial institutions," he said. Although he stops short of endorsing underwater homeowners from defaulting, he does make an argument that banks might be more inclined to lower the principal balance on inflated home loans if more borrowers did just that. You may read his paper here.
