The NPR Planet Money team discusses the phenomenon of “Strategic Default” in which an underwater homeowner chooses to default on his mortgage because it is fiscally advantageous.
In one particular case, a homeowner bought at the top and owed $400,000 on a home in a neighborhood where the average home sale had declined to $250,00-$300,000. The homeowner decided to default on his mortgage, take a 200+ point hit to his high FICO score, and buy a new home in the same neighborhood.
The real estate attorney on the show says this may be a peculiarity of Arizona law (she practices there). Homeowners there can’t be sued by a bank if they default. In other states the bank could sue you if you tried something like that, smartypants.
But it made me wonder if this happens in Santa Clarita?
If you follow the local real estate scene (and the dozens and dozens of largely worthless but occasionally decent real estate blogs), you’ll find a common theme these days: There are plenty of empty homes in Santa Clarita, but they aren’t available for sale because the bank hasn’t completely foreclosed on them. Supply, as a result, is tight and demand remains high, yet construction has ground to a halt.
Since the housing bust began, I’ve thought the foreclosures in town were due to ARMs maturing or people losing their jobs; I hadn’t considered that some might be intentional. If you divorce yourself from the emotion of losing your home and just focus purely on what you owe versus what your home is worth, it might be tempting to default on purpose, especially if you could recover quickly and buy somewhere else.
Do you know anyone in the SCV who has willfully stopped paying their mortgage because it just didn’t make sense anymore? Come on, let’s hear some dirty secrets!
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Haven’t stopped paying the mortgage, but the thought has crossed our minds to buy a second house and walk from the townhouse we’re currently in. Now that prices have dropped so drastically, we could get a house on several acres for our doggies to run wild and the hubby to have goats (don’t ask) and get out from under an HOA. Yeah, I know, why buy in an HOA in the first place, but it was all we could afford at the time. But nah, while the thought has crossed our minds, we would never walk from the townhouse. Sadly the goats will have to live on the postage stamp sized patio.
You have goats now KLB? Now I know why the coyotes are in the area.
I’m contacting the HOA about your goat problem. errr wait
ps- don’t our neighbors have chickens?
Yes! I think it was here recently that there was an article linked about ghost inventory, right? That is EXACTLY what is going on in the SCV. It’s going to implode, I’m sure of it!
Not only are their empty homes all over the valley that are sitting waiting to be foreclosed, their are OCCUPIED homes all over the valley waiting to be foreclosed. People are living in their homes mortgage free for easly 18 months or more before the bank gets around to foreclosure. All those mortgages that were set to adjust last year and cause this big forecloser boom….ITS HAPPENING….in the shadows. The owners will likely continue to live in those homes until the last minute, often times receiving ‘cash for keys’. People are waiting until the last minute, I mean, what reason is there not to?
The same laws that encourage this type of default in AZ encourage it in CA. I’m not sure the nitty gritties of it, but basically any loans used to purchase the property are non-recourse. The bank can’t come after you for the difference.
Banks aren’t quick to default. They don’t have the man power to handle the paperwork/sales end of the situation and certain don’t want to be responsible for the care and keeping of the home while it waits for their bureaucracy to catch up. Esp in a neighborhood w/an HOA where maintenance issues quickly turn to liens on the property. The banks want those homes in their name like a hole in the head.
I don’t think that the SCV has seen a lot of strategic default yet, but I think it will. Home prices are still too artifically high. In AZ you can buy your neighbors house for 1/4 what you bought at. During your 18 month foreclosure process you could save up that $80 or $100K to buy the neighbors home in cash. We have friends in AZ who bought in 04 for $400K and recently bought a (smaller, rental) home in their neighborhood for $75K!
We bought a condo here in 99 that the previous owner had strategically defaulted on. He paid $185K for it, we paid $85K for it. We sold it for $255K and the new owners sold it for $355K. All in a matter of less than 10 years. Crazy stuff!
What about all of the homeowners who’ve used their home as a piggybank to get the Mercedes, trips, cars for the kids, plastic surgery, boats, RVs, etc., and then get foreclosed on. I would say that is strategic, they have all the stuff they just don’t have a home that has been mortgaged to the hilt.
And they can be held financially liable for the debt, because it was a refinanced loan. There may be exceptions, but that is my understanding. Of course, there is always bankruptcy to clear that debt if they are in a dire situation, so it would still be possible to forgive the house debt, just not as easy-clean-sweep as a purchase debt is.
As far as the repurchase scenerios, though, I think our high housing prices are what have kept that from having (in large numbers) so far. Lenders are understsandably more conservative and I believe most government backed loans have a 2 or 3 year waiting period after a foreclosure or short sale. It’s unlikely people would be able to save up the funds for a cash purchase. But I do know people who have purchased in another name (ie, defaulted loan in husbands name, new loan in wifes name). I think for are area the majority of ‘strategic defaults’ aren’t necessarily running out and re-investing in our RE market, rather they are pakcing away tens of thousands of dollars while they sit in their homes mortgage free and then going out and renting a nicer place for 1/2 what their mortgage was. I imagine we’ll see a huge onslaught of ‘first time buyers’ (those who have waited out their 3 years post foreclosure) in a couple of years.
I look forward to your dish LOL.
I live in the 91354 and I see it happening around me. I know a number of people who are in limbo. Just sitting around waiting for their homes to be foreclosed on. Eventually these things will hit the market, likely all in one fell swoop. It’s going to be bad IMO.
And it’s not about income and being able to afford ones home. Most of the people I know who are walking away are perfectly ABLE to afford their homes, they’re just not WILLING. It’s such a rough concept to grasp. On one hand, it seems so ethically wrong to skirt your obligation. On the other, if it were a business we would be praising their business sense. Abandon cash draining liability and reorganize, come out ahead on the other side.
One has little choice but to blame it on the Democratic congress which eliminated the tax implication (debt forgiveness) from the tax code. It used to be that a 1099 was issued by the bank to the borrower and the IRS when the debt was written off the bank’s books. This increased the moral hazard that others would walk away from their homes. It really comes back to Barney Frank, Chris Dodd Dodd , and Barack Obama.
Jeff ~
Nah, no goats. If the hubby could find a way to have a goat without the neighbors knowing, I’m pretty sure I’d come home one day and find a goat on the patio.
That coyote may be the reason I’ve seen a decline in raccoons this season. We were visited almost nightly by raccoons last winter. This winter? Not so much. I miss my little raccoons.
Ya know, I haven’t heard any chickens from the house next door, but it does sound like they’re running a dog breeding business over there. But it wouldn’t surprise me if they were raising chickens. Now I’ll have to investigate.
Mortgage Debt Relief Act of 2007 passed unanimously in the Senate by 386-27 in the House and was signed by President George W. Bush.
Next!
That is why I said a Democrat congress-which included the three stooges.
Do we have a CPA in the house? Even before the debt relief act you could claim insolvency and avoid taxation on the debt. I wonder just how insolvent one needs to be to make such a claim, what type of proof you needed to provide, etc. As in, was this a common way to skirt this debt prior to the relief act?
passed by both parties, don’t be dishonest.
Gotta be honest, my wife and I have, and will continue to strongly consider it.
We bought at the peak. July ’07. We needed in. We both knew that it was at the peak, and that prices would decline, but not to the extent that my little enclave did. The default notices flew up like a ream let loose in the wind at our place, and prices fell through the floor. (Assessor’s value is currently at 54% of our purchase price… and we’d be lucky to get an appraiser to sign off on that high of a number)
As a result, we can’t refi to lower our interest rate to anywhere what the market rate is today. LTV is way too high!
Now, we’re not in a position to get helped out by the federal programs. We both still have our jobs, and no major change in income status (tho we’ve both had our bonuses eliminated, and our salaries frozen). But the bank (Wells Fargo, I don’t mind besmirching) refuses to negotiate with us to lower the interest rate from the nearly 8% that we got, down into the 5% range… because we’ve made all our payments, and we’re not at risk of defaulting.
So, whats our only option to get the bank to play along? Intentionally start missing payments?
If the bank would reward good, honest, able to pay customers… perhaps they’d see a bigger upside to their business.
But at this point, if my home were my business, and I were making a financial decision alone…. I’d walk away.
Over Christmas Obama gave FNMA and FHLMC unlimited access to government funds for continuing operations. This is the first step in a massive loan mod. program that will allow the government to write off huge chunks of under water mortgages in their portfolio. An actual stategic default like that in the NPR piece is nearly impossible since Fannie and Freddie now require borrowers getting owner occupied mortgages to prove a large equity holding in any properties they currently own.
Todd:
“If the bank would reward good, honest, able to pay customers… perhaps they’d see a bigger upside to their business.”
Really? Didn’t you sign on the dotted line when you took out your loan? We bought our house in ’98, saved our money and were able to put down 20%. It’s not the biggest house in the SCV. It’s a very modest house in the SCV. Today it’s still worth a little over half of what we paid. At one point it was 4 times as much as we paid. We didn’t take money out of it to buy big toys. The only thing we did was refi from 7.25% to 5.25% so that we could save money and pay it off sooner. I’m sorry, I don’t have a lot of sympathy for those that bought in an overinflated market. I kept saying for years that is was going to “pop”. I’m just surprised it didn’t happen sooner. I do think that there should be bigger penalties for defaulting. I’m sick of listening to all the whining. If all these people who bought when it was high had just waited until the bubble popped they could have bought at a reasonable price. It didn’t take a genius to know that it was going to “pop!”
Just my two cents.
I’m with Sarah on this. Mostly the greedy and naive are getting burned. 100% + appreciation between 02 and 07? Unsustainable. Wasn’t 3% a year the norm? Let’s go back to 02 prices, add 3% a year and start from there.
http://www.zillow.com/local-info/CA-Santa-Clarita-home-value/r_54311/#metric=mt%3D34%26dt%3D1%26tp%3D6%26rt%3D8%26r%3D54311
Same here, with Sarah 100%. It seems odd how those that opted for bigger homes than they can afford are getting rewarded by loan mods or principle adjustments. It should be those that put out more $$$ for down and picked homes w/in their means that get some sort of incentives.
I can’t totally agree since my daughter and son-in-law are in the upsidedown boat. Soon after they married in ’05 they bought a crackerbox condo for what the owner said was a terrific deal at $325k (the same was selling at $350). A month ago, the same condo sold for $78k. Their balloon is due in Sept. No way to refi the balloon and why would anyone want to. On the other hand, the toys for boys crowd have had a short lived period of hilarity and are now paying for it.
Sarah and I think the same way. I was flabbergasted when people kept refi’ing and pulling ridiculous amounts of money out of their $300k home, they had no intention of paying it back, now the debt is somewhere around $600k. They have not paid their mortgage for over a year and have been banking their money. Now they tell me the bank is going to give them $5k to vacate!!!
Silly me, I put 20% down on a home I could afford and have been paying my bills every month. I don’t drive an expensive car, have an RV or boat, and don’t take fancy trips. Gee, who looks like the idiot now!
But at the same time plenty of people DID put 20% (or more) down and are still hundreds of thousands of dollars upside down on their homes. Like I said before, if it were a business, we would be praising their sense. When it’s an individual, we question their ethics.
Walker, you are absolutely correct. Companies do this kind of thing all the time.
“were a business, we would be praising their sense. When it’s an individual, we question their ethics.”
Sarah-
As ludicrous as it sounds, Yes. Really.
While the defaulting owners are certainly to blame for getting into something they could never have afforded in the first place, are not the banks, mortgage brokers, real estate agents, and escrow people who were making cash hand over fist while turning a blind eye to what was happening equally, or more to blame?
I didn’t buy a house I couldn’t afford. I didn’t buy because some sleazy broker said “hey we can make your payment on a $500k home only $1100/month” and then mutter under his breath “for the first 3 years, then it goes up to $4500/month for the next 27 years on a variable rate.”
The banks made a business decision to loan money to Starbucks barista’s who could only prove minimum wage income, but claimed to make $5000/month in tips (yes, this is an actual example of a loan that was handed out). Why shouldn’t I make the same business decision?
Corporations walk away from their debt all the time when their cash flow and value of their assets don’t add up to their liabilities… its called bankruptcy! Why shouldn’t we, as debtors do the same thing that they do when fiscally it doesn’t make sense for us to continue the business relationship?
I am one of those owners who put down money on my house. And I’m still upside down thanks to all those who live in my neighborhood who didn’t. Will it come back? Maybe? In time for my needs as my family size grows? Not likely.
So what should I do then? What would a corporation do?
“If the bank would reward good, honest, able to pay customers… perhaps they’d see a bigger upside to their business.”
Banks call such people “deadbeats.” Really.
If you pay your bills on time they do not make interest or penalty money, and the greedy ba$tards resent you for it, calling you a “deadbeat” behind your back. $crew ‘em.
Todd,
You’re not telling me any argument that I haven’t already heard, but you signed on the dotted line. We saw this happening. Incomes were not increasing at the same rate that home prices were increasing. I agree the banks are greedy, but in a way weren’t you biting off more than you could chew? You are supposed to read those documents before you sign. Everyone knows an ARM can be a potentially risky loan. You’re gambling. You can’t go to Vegas and double down on a hand of black jack and then all of a sudden say, “Oh, I didn’t mean to do that” when the dealer deals a losing card.
Your argument that it is a good business decision doesn’t fly with me either. If some people are stealing from the store, does that make it alright for me to go ahead and steal from the store? You’re an adult and you made a bad business decision and now you want us to pay for you mistakes. Sorry, I still don’t have a lot of sympathy. I bought modestly so I could sleep at night. People can blame the politicians and banks all they want, but ultimately they are responsible for their actions. It’s funny how we all want to find someone to blame. It’s never our own fault. We need to take responsibility for our actions even if it is hard to do.
Navigator, no one held a gun to your daughter and son-in-law’s head to buy a condo at a price they couldn’t afford. The too signed, and are ultimately responsible to pay back what they borrowed.
I know it sounds harsh, but it’s what I believe. Maybe we all need to take a little finance class in high school. My mom and dad were children during the Depression and they passed their experiences on to me. I’m thankful that they did. I can sleep at night and not worry about the “repo man” coming to get me.
Sarah,
In essence someone did hold a gun to their heads. This was the cheapest place they could find in what I would say isn’t the best place to live. It’s what they could afford at the time. You’re right, though, that ARM loans are ticking time bombs and theirs is about to explode. My son-in-law would rather die than walk away from this mess and if he could refi the loan he would. The bank that was more than happy to make the original loan won’t even consider a refi at the current value of the home. Fine. They can have it back.
Sorry Nav. but even if it was the “cheapest place they could find” it seems they could not afford it beyond the” teaser” rate so they should not have agreed to the terms of the deal in the first place. It was in writing and they signed up for it. Don’t blame the banks for their “big eyes and small stomach”.
Navigator – you’re kidding, right? Who made them buy a house? There are plenty of rentals on the market in the SCV, I know, I rented until I had my 20% down.
Did anyone take their tax returns which should have been large considering the interest is tax deductible and pay down their principal or save for the balloon payment or…just buy more toys?
I would like to retract my above comment. It was mean spirited and does not belong here. I am sorry.
Jane/CC, thanks for your opinions. They don’t live in the SCV but that has nothing to do with it. The kids could have saved their down payment of blown it as they continued to rent for what amounted to a house payment but, like you and me, they chose to have the American dream: own your own home. They could and still can afford the payments but coming up with $250k for a balloon is a little beyond their reach. You and I are able to weather this storm but our kids are in trouble and their kids will be in more trouble if things keep going the way they are.
Want to hear what Realtors across the country have to say about ‘Strategic Defaults’?
Go to
http://activerain.com/blogsview/1472785/the-ethical-dilemma-of-strategic-walk-aways
It’s clear that strategic default benefits Realtors, but I think it’s unnecessary to find a ‘guilty party’ as the article (and the opinions of so many) suggests. The fact is that home ownership is a business decision. When that partnership becomes a burden, it often times makes sense to sever the relationship.
If you are heavily upside down on your home (regardless of down payment or loan type, this is the case for MANY homeowners) and projections suggest that you will CONTINUE to be very upside down on your home for the foreseeable future despite a payment that is far above market rate for a similar rental, it’s time to rethink the business relationship. If you were to walk away, what would your financial situation look like in 2-3 years when you can repurchase? What would it look like in 7 (or is it 10?) years when the foreclosure finally scrolls off your credit report? How will the decision affect your financial picture overall? Chances are, for MANY (yes, even those w/significant down payments and conventional loans) the financials of it would suggest that they foreclose.
The business end is easy, it’s the emotional relationship you have w/your house, and the pride relationship you have with your community that are tough to overcome. But, when you look at it from a business standpoint, it’s a no brainer.
Nav. Did your kids ever think they would pay a $250,000 balloon payment or were they just speculating and got burned?
Castaic – They anticipated their income would at least be at the same level it was when they bought and that they would be able to refi the balloon. Neither happened. Most don’t speculate on their first home.
anticipated=speculated
Tax deed sales business will surely reach a tipping point in the very near future. Events in the foreclosure field are fast juggernauting towards causing a massive tipping point. Banks must pay fees when attempting a foreclosure through the courts. Banks try to avoid this is much as possible. Banks rarely, if ever, pay the property taxes. If the taxes are not paid the counties will sell the property at a tax deed sale. When the volume increases, and time runs out, the tax deed tipping point is reached, and opportunities for the tax deed investor will become absolutely fabulous!