Thursday, March 11, 2010

Strategic Default Employed By Manhattan Condo Owners Seeking To Get Loan Modifications

In a recent Real Deal article entitled "New Manhattan Condos See Rise in Foreclosures". The essence of strategic default techniques employed by condo owners are contained in the following quotes. Mind you that these are high end luxury condominiums presumably owned by upper income individuals. The article points out that investors own many of the properties that are now in distress. In other words, the properties were purchased to rent and flip for a large profit. Now these owners are strategically defaulting in order to get a loan modification.

Let's look at the relevant quotes from the article briefly describing the strategic default strategies:

  1. They intentionally fall into pre-foreclosure to encourage the bank to lower their interest rate, which can shave thousands of dollars off their monthly payments. Several owners contacted for this story said they successfully used this tactic and are no longer technically 'in foreclosure.'"
  2. Sometimes an owner will not pay the mortgage for several months as a strategy to encourage the bank to modify the terms of their loan, by "proving" the loan can't be paid under the original terms, but could be under better terms.
  3. And the foreign investor at the Cipriani Club who owns several units in pre-foreclosure claimed that he is intentionally not paying the mortgage so the bank will modify his loan, said a source within the building.
  4. An owner of another apartment at the Downtown Club with a lis pendens filed against it, said he 'took a break' from paying the bank and was able to negotiate his monthly mortgage payment down from $3,300 per month to $2,000 per month. "I own a construction company and business went down. I own several properties," the owner said last month during an interview at his apartment, explaining that for a time he couldn't make payments on all of his properties at once, but knew the bank would cut him a deal. Ultimately, he said "the bank agreed to move his unpaid balance to the principal and reduce his interest rate from 6.2 percent to 3 percent...It's a shame that a lot of people let their units get foreclosed on without knowing they can do something."
  5. Others are not so lucky, like a creative professional who said he'd probably lose his apartment at be@Clinton West...Records show he purchased his studio apartment in 2007 for $507,000 -- 25 percent more than the previous owner paid three months earlier -- with almost zero equity by taking out two mortgages. The owner says in the article, "My one loan is about 8 percent interest only and the other is 13 percent interest only," said the owner..."I was told by an associate at [lender] SunTrust...that this is probably the only way I could get a mortgage and that I could refinance a little down the road with equity...I knew going in that it was a ridiculously high interest...But I thought I would live tight for a year or so and then refinance based on the equity, which at the time seemed like a great plan. I'm not saying I was coerced, but I was excited to buy my first place". Unfortunately, his business declined along with the economy, leaving him with no money to put toward equity. He said the bank has refused to modify the terms of his loan.

Of course, there is not much sympathy for investors who lost out on their bets for quick profit. However, most individuals who purchased properties did so to make a profit over time.

Is it right for an investor to strategically default in order to improve their investment?

What do you with a property that has no equity and requires high monthly payments that draining cash and savings?

At this time the answers appears to be "Yes, strategic default is an effective business and financial tool"

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