Strategic Default, finally

Story as it ran in Palm2Jupiter:

Three years ago, when sales rep India Haass, 62, moved from Tequesta into her new Lake Worth vacation rental compound, it was a dream come true. Living in one of the cottages, she could get rental income from the other three units, and she thought it a perfect retirement plan.

But problems arose quickly. The economy turned, and with it, the summer vacationers she had hoped to attract failed to materialize. Then her partner in the venture was forced to take pay cuts, and, later, decided he wanted out of the deal altogether.

That left Haass doing all the work and making all the payments on an apartment complex in the $400,000 range with a loan balance of $525,000 – an impossible commitment based on her salary, as well as a losing business proposition.

It’s not that she hadn’t tried to make it work. “We had already put our place on the market for more than a year, but we didn’t receive any offers,” she said. So, a short sale was out of the question.

“We had already worked out one loan modification when my partner took his first pay cut, but then, when he wanted out of the deal, I had to go back to the bank.

“They asked me if I wanted another modification. I said, no, because I couldn’t carry the house alone.”

In July, she told the bank she wanted a deed in lieu and a guarantee that it would forgive the deficiency.

On October 1, still waiting to hear from the bank, she packed up, moved back to Tequesta, and stopped making payments.

“It depresses me,” she said, her eyes filling with tears. “I’d have liked to make it work, but a person can’t keep flushing money down the toilet when there’s no end to it.”

Strategic Default
Haass is not alone. A number of underwater homeowners take the steps to walk away. While some, like Haass, are undergoing hardship, others are strategic defaulters, with the financial means to continue making their payments.

“There’s nothing illegal about defaulting on your mortgage. People have been doing it for years,” said Matt Englett of KEL Attorneys, a law firm with statewide foreclosure and bankruptcy cases.

“Strategic default means that the person involved considers the home to be a formal investment and has chosen to default because it’s an unwise business decision to continue to owe the bank.”

Mortgage broker Jim Sahnger, of Palm Beach Financial Network in Jupiter, describes the dilemma facing one of his underwater clients, who owes $900,000 for his home, and who spent another $500,000 for improvements. Because of foreclosures in the neighboring community, the home now is valued at $600,000.

“Should he stay or should he go?” Sahnger asked. ”It’s not like he can take two aspirins, and feel better in the morning.

“Sometimes it’s better to walk sooner than later.”

Higher Number of Strategic Defaults with Loan Balances Greater Than $1 Million.

According to CoreLogic’s most recent negative equity report (2Q 2010), when the loan-to-value ratio rises more than 125 percent, default rates rise dramatically.

There are about 4.8 million homeowners in that group, and, of that group, 27.58 percent of Florida homeowners with loan balances greater than $1 million are defaulting (more than 90 days late), as compared to 17.29 percent of the homeowners with loan balance less than $1 million.

And although Florida’s numbers are one of the highest, this trend is national — 13.13 percent (for $1 million-plus) as compared to 7.8 percent (of less $1 million).

CoreLogic can’t analyze how many of those are actually strategic defaulters. “We don’t have data that specifically differentiates what is and isn’t a strategic default, because to do so, we would essentially have to read the minds of those who default and determine why they defaulted,” said Sam Khater, CoreLogic’s senior economist.

“It’s important to note that not all of those are strategic defaulters, but many more within this bucket (LTV ratio greater than 125 percent) will be, as compared to those with more equity.”

An Experian – Oliver Wyman Market Intelligence report from June 2010 does pin down the number of strategic defaulters. Nearly one in five, or 19 percent, of mortgage delinquencies were strategic defaults in the 2009 time period they studied. And in Florida, strategic defaults ran 53 times higher than they did in the 2008 time period.

Like CoreLogic, it found strategic defaulters had higher mortgage balances. They had higher credit scores, too – 28 percent of delinquent borrowers with a VantageScore (the credit score compiled by Equifax, Experian and TransUnion) between 901 and 990 became strategic defaulters, a 50 percent higher rate than in the overall delinquent population.

KEL attorney Matt Englett estimates that 10 to 20 percent of his firm’s 7,000 open cases are strategic defaults – a hefty number, he points out.

His “average” strategic default client has a six-figure income, has a good retirement account, and has some assets, he said. “On average, they owe about $400,000 and their home is worth half of that right now and they can be looking at a loss of $200,000 or more.”

For these clients, attorneys at his firm analyze the clients’ assets and create a strategy for asset protection. Then they develop the defenses for the foreclosure litigation.

These services cost around $3,500 to $4,500 to handle the whole case. In addition, his clients do end up paying the bank between 10 and 70 percent of the loss, depending on the client’s financial situation and how well his or her assets are protected.

There are legal ways to protect assets and there are good fraud and inducement defenses that will help defaulting homeowners, he said. “There are no absolutes, but by-and-large, if the clients don’t have millions, I can minimize drastically what they lose on these properties.”

Moral Issue or Business Decision?
Issues of morality about this do come up, he admits, but, in his opinion, they shouldn’t.

“These kinds of complaints should not play into making a financial decision. Businesses and investors don’t do that.

“These are collateralized loans and the home should have been appraised properly, with the borrower making a down payment. If the banks had done that, they would get the home back, and that’s the way it works.

“In the majority of states (not including Florida), banks don’t have the option to sue you personally if you default on your mortgage.”

The problem is, the banks often lent 100 to 110 percent of the purchase price, and they are already doing it again, he said. “They are lending 100 to 104 percent of the purchase price – even Fannie and Freddie – and that’s a recipe for disaster.”

Jack McCabe of McCabe Research and Consulting believes more people who can pay will choose to walk away. And he doesn’t see why they shouldn’t.

“American corporate businesses say they should walk away from a bad investment,” he said. “Simon Property Group just let five of its properties go into foreclosure when it could have paid, so how can you tell the American consumer that he or she is grievously wrong?

Barbara Cohen, Illustrated Properties, director of distressed property sales, also sees this trend continuing. “There are definitely more people saying, ‘It’s upside down and it’s not a good investment for me and I want to get rid of it.’

“We are seeing a number of higher priced homes going into default. People of means have more alternatives at their disposal and they have attorneys.”

On the other hand, Shari Olefson, a Miami attorney, mediator and author, said if you do the math for strategic default, it doesn’t work out. “Talk to a credit counselor. How your credit will be affected has to do with your particular case, how many payments you are late on, and so forth. The more you are screwed up, the more your credit will be affected.”

Fanny Mae just issued a statement, she said: “If you do a short sale, you can buy a home in two years. Deed in lieu, four years. Strategic default, seven years.

“So, how much rent are you going to pay over the course of those years? Is it worth it?” she asks.

Englett’s firm, though, does consider those credit issues. “Although a client’s credit score will go down by 100 to 200 points, it will recover in 12 months, maybe less if you do some credit repair,” Englett said. “However, you cannot get another home mortgage for four years. This is why many strategic default clients who want to own a home will buy their new home before they default on the current one.”

Those defaulters fall into the category Olefson calls “Buy and Bail.”

“An owner applies for a loan for a home priced at $450,000 next door to his home,” she explained. “Then, he walks away from his home that he bought for $600,000. You think the loan officer for the second house didn’t know that he was going to default? The guy’s house was just next door to the one he was buying!”

Key findings on Fannie Mae National Housing Survey released Sept. 16, 2010:

Nearly two in ten consumers know someone who has strategically defaulted, or stopped making mortgage payments even when he or she could afford to make them.

Delinquent mortgage borrowers and those in the general mortgage borrower population both are more likely to have seriously considered stopping their mortgage payments if they know someone who has already defaulted – almost twice as likely among delinquent borrowers (40 percent among those who know a defaulter, versus 21 percent among those who do not) and more than three times as likely among mortgage borrowers in general (7 percent versus 2 percent, respectively).

Eighty-five percent of Americans do not believe it is acceptable for people to stop making payments on an underwater mortgage, while 10 percent believe it is acceptable. But 19 percent of delinquent borrowers think it is acceptable to walk away from a mortgage. And 38 percent of delinquent borrowers think financial distress makes stopping payments acceptable.

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