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.

Strategic Default, Florida

Interview with Matt Englitt, KEL Attorneys, Florida, September 28, 2010

Define a strategic default:

There’s nothing illegal about defaulting on your mortgage. People have been doing it for years. This is nothing new.

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.

My firm is a full service private law firm working throughout Florida. We can do everything, but in this economy a lot of our caseload is foreclosure and bankruptcy.

Profile of someone who decides to pursue a strategic default:

Maybe ten percent to 20 percent of my foreclosure cases are strategic defaults. We have thousands of clients, about 7,000 open cases, and between 700 and 1,400 are strategic defaults, and that’s a good number.

My average strategic default client has a six-figure income, has a good retirement account, and has some assets. On average, they owe about 400,000 and it’s worth half of that right now and they can be looking at a loss of 200,000 or more.

What is the procedure for a strategic default?

First part of what we do is create a strategy for asset protection, so we have an in-house attorney, who will sit down and advise the homeowners on protecting their assets.

Second, we develop the defenses to the inevitable foreclosure litigation.

There are lots of defenses on behalf of homeowners that will let them out of their mortgage, minimizing their losses. They will have to bear some of the losses, but they will be able to minimize their loss on the property.

Lets say that the bank takes the house back and there’s a loss of $100,000. My client will not have to bear the whole loss, the bank will take some, and my client will take some, too.

What about short sales and deed in lieu?

Sometimes, as resolutions to our cases, our clients can do a short sale or deed in lieu, these are alternatives to strategic defaults. A short sale is just one way we may resolve that case and the bank might want us to do that. The bank may say list the house. A short sale does not have to be a hardship case.

With a short sale, the key component is that the borrower is responsible for the deficiency. The bank could let you out, or it could reserve the right to sue you down the road. We negotiate that with every client.

Banks don’t look at hardship when doing a short sale. Early on, a year and a half to two years ago, when it was at the height of foreclosures, banks wouldn’t put up with a fight for a deficiency. Now, it’s difficult to get them to waive the deficiency.

In those cases, I advise the client against doing the short sale.

What is the defense?

If you don’t do a short sale, and then go into the litigation of the case, the lender will file a foreclosure, and that’s when we will do all of our legal maneuvering right there. The lender realizes it will be a heck of a fight and realizes it may not be able to get the house back for any number of reasons.

For example, we have a good fraud and inducement defense — that the bank lied about the terms of the loan. Or some banks did appraisal shopping, to get the high number that they wanted so that they could get a big loan.

These are some of the defenses that the banks see we can prevail on and puts pressure on the banks not go the distance in the case.

What are the consequences to the homeowner who decided to pursue a strategic default?

Normal outcome: I hate to just throw a number at it. A typical resolution depends on the client’s financial position. If the client has money, he has to come up with a portion, and cover 10 to 70 percent of the loss.

If client doesn’t have much money, or if their assets are protected, then I can get them an even better deal. It depends on what the bank can get from the client. That’s why we do the asset protection before the client defaults.

Asset protection all depends on how your assets are titled. Oftentimes, we have a husband and wife come to us and the note is in one of the spouse’s names and all the other assets are held as a married couple. So the bank can’t go after joint assets of the husband and wife, because only one signed on the note.

So, they need to get assets into being held by husband and the wife. 401Ks are completely exempt from creditors, and, in Florida, your homestead is completely protected from the creditors, so the couple can go out and buy a home with cash and that would be protected. They can go buy a house for a bargain, now, and put a good chunk of cash on it and it would be completely protected from their creditors.

How much does it cost?

For strategic default, we start at $3,500 for coming up with strategy and doing the litigation until its resolved, but coming up with a strategy could cost a couple thousand more, but usually $3,500 to $4,500 will handle us doing the entire case.

What about the morality issue?

We do see complaints of issue of morality with strategic defaults, but we don’t think that should play into making a financial decision. Businesses and investors don’t do that.

These are collateralized loans. The bank should get your property and your property only. In many states, the banks don’t have the deficiency option — the legal right to sue you. They get the property back and sell it. The bank is supposed to lend a certain amount of a property’s value, so if the property goes into default, they get the property back. In a majority of states, they don’t have the option to sue you personally if you default in your mortgage.

Sure, the banks didn’t know that property values would drop so much, but they shouldn’t have risked so much money thinking that it wouldn’t drop, and they should not lend such a high ratio – they’ve loaned 100 to 110 percent of the purchase price — they should lend only a potion. That way, the owner has to make an investment. That’s suppose to be the way it’s done, but the banks make so much money off lending money.

And as a side note, the banks are already back doing it again. They are already back to lending 100 percent of the purchase price, and they are back to the same whole thing, including Fannie and Freddie – they are not making homeowners come up with down payment. Now, when a default happens, the money comes out of the taxpayers’ pocket. The banks are loaning 100 to 104 percent of the purchase price and that’s a recipe for disaster.

I think you’ll see more and more people strategically defaulting. Because, if you see the financial analysis that we sit down and do, if the homeowners bought in the bubble at the height of the boom, they won’t be able to pay off their loan for 15 to 20 years.

And, that doesn’t include renting a house that’s very similar to their current home, for half of what they are paying every month to own their home. So, if you combine those two numbers, they are losing well over $100,000, sometimes $200 to 300,000, and it doesn’t make sense to keep it.

Develop a strategy and do the asset protection, listen I’m not going to minimize. There’s a lot I can do for you.  Sometimes, some people have so much money, there’s not much I can do for them. But sometimes I can do something. For example, they might be able to take the money, put it in a trust. They’d have to wait two years before they can default. Sometimes with asset protection, you have to wait until you fall behind; otherwise it’s a fraudulent transfer. There are no absolutes. Always a risk, but by and large, clients that don’t have millions, can minimize drastically what they lose on these properties.