Strategic Default Monitor – How To Strategically Default

Sunday, April 25, 2010

Got Questions? Get Answers...Clueless Is Concerned About What The Lender May Do If She Pays Off A Loan From Her Parents While Pursing A Short Sale On Her Underwater Home

Got Questions?

Hello. My husband and I are currently in an "underwater" mortgage. Our loan was for $262,000, which we have paid down to $253,000. The general consensus of realtors, is that we should be able to get between $215,000 and $220,000 for our home. Our mortgage is with Bank of America. We hare hoping they will forgive this amount and allow us to complete a short sale. My question is in regards to a savings account that we have. I had a $30,000+ student loan. The rates on the loan were going way up, so my parents took out a home equity line of credit, several years ago, and to pay off the loan. Here's where I made a mistake. Instead of making monthly payments to my parents, I have been putting money into a savings account, with the intention of transferring the money to my parent's account, when I had saved the total amount that I owed them. In this savings account, I have the exact amount that the payoff of the student loan was. It's not money I'm trying to hide from the bank. It's money that I rightfully owe my parents. However, I understand that if I close the savings account, obtaining a check for the full amount in the savings account, that would thus be deposited in my parent's account, it will look very shady to the bank. In other words, I am preferring to pay my parent's back the total amount of my student loans, yet ask the bank to forgive a similar amount on my mortgage. How can I LEGALLY safeguard this money? I don't want to put myself, and more importantly, my parents, at risk for what could be easily MISunderstood as a fraudulent transfer (which could mean fines, restitution orders, probation, imprisonment, crime, etc...) I've asked this question to someone a few days ago, and they dismissed me, as if I were asking them to take part in something illegal. I have the student loan payoff documentation, as well as all the payments that were ever paid on the loan, which was by my parents. It is a valid debt to my parents. I don't have a certified letter stating that I would pay my parents back by a specific date and time, etc, etc.... I have great parents and they knew I would repay them. I never thought to compose a payback agreement, for goodness sake. I also never expected to be in an underwater mortgage. My parents have helped us for the past few years, when the mortgage companies have repetively turned us down for refinancing or streamling of our loan, because we weren't delinquent on our payments. It's frustrating. My parents deserve way more than simply the money from my student loan. I want to pay them back, at least for the student loan, before we lose everything, including our credit rating, in a short sale, or deed in lieu situation. I've received a whole spectrum of advice...including not reporting that I even have that savings account to putting the money in an IRA. But it still seems to me that the bank will find this money. Could I take my husbands name off the account and add my dad's name? If my dad's name was on the account with my name, would that prevent the bank from being able to take the money? UGH...please, please help me. There are so many terms being thrown at me and so many laws...I am confused, overwhelmed, and feel stuck in a terrible situation. Please help me. I would appreciate any advice you can provide.

Thank You In Advance

Clueless

Get Answers…

Dear Clueless:

Yes, it is true. When seeking a short sale from a lender, the lender requires disclosure of your finances. I do not recommend that you try to "hide" information from the lender. If the money is in the savings account when and if a lender agrees to a short sale, then a lender has the right to the money and an expectation that you will use the savings to pay the remaining debt.

If you owe a debt to your parents then you should pay them back. As long as there is an agreement between your parents and yourself re: the loan, then why not honor the terms of the loan and pay back your parents. It seems that this loan predates any deficiency with the lender.

A fraudulent transfer normally means that money and/or assets are moved around in order to prevent a creditor from collecting on a valid debt.

You are asking great questions. Once again, if you have a valid loan agreement between you and your parents then pay your parents back. If not, then you must be upfront with the lender and negotiate how much of your savings the lender is willing to let you keep.

Of course, let me add that you can and should seek the advice of an attorney and/or accountant in your state. This way you can properly explore all legal and financial options.

Good luck. I am confident you will work it out.

Thanks.

Augustine Diji

Got Questions? Get Answers...KC Is Prepared To Strategically Default But Not Sure

GOT QUESTIONS?
To Whom It May Concern:
I read your website on Strategic Default and would like to put forth our situation to hear your opinion. We purchased a condo during the condo conversion craze in So. Florida in 2005. Purchase price for a 2/2 in a highly sought after area was $178,000. We put 20% and did a 7 year libor interest only. We pay our taxes separately each year. After having closed with the lender referred by the developer's sales office (Countrywide), we found out later that the association had over $250,000 in liens that were against the developer for various maintenance improvements prior to converting units and from the city for infringing on landscaping regulations. The association hired an attorney who is actively dealing with this but in the meantime, Hurricane Wilma hit and the condo association suffered tremendous damage (still has roof damage that is unrepaired). Meanwhile, we continued paying our association dues($400/mo) and additional assessments ($4000). We have lost our water and cable vendors due to inability of association to meet its debts,therefore, those costs are now incurred by condo owners (they did not reduce assoc. fee since attorney states that condos are still "underwater" with debt). The unit is now worth $71,000 according to Bank of America (I inquired to see if we qualified to refinance-they won't). In some cases, units are being bought for $30-$40K/ea by investor groups. We have totally refurnished our unit, tile, granite, new a/c, new appliances, paint, etc spending over $4000 and we can't even declare it as a loss on our taxes b/c of my husband's income bracket ($250K/yr). We own three other properties, have great credit -780 score, never have been late on a payment and have our properties rented out. In the case of the condo, we are losing about $150/month since we had to rent at a discounted price to compete with rental market. I inquired with Bank of America who assumed the condo note from Countrywide and they could not recommend any department that could qualify us for principal reduction. The only good news that may or may not happen is that the libor index may go down in July when our rate adjusts. We are willing to strategically default just because we will never recuperate our investment and the condos are falling apart (100 out of 340 units are in foreclosure). The property management company and board of directors are no help at all. The attorney is not responsive to inquiries. What would you do?
Best regards,
KC
GET ANSWERS…
Dear KC:
We agree, it is likely you will never recover your investment in the condo, so what is the point of throwing money down the drain. Your mortgage balance is about $142,400.00. This is much higher than the $71,000 value of the unit. It may be less; you said investors are paying $30k to $40k per unit. There is no positive cash flow. Your possible upside to continue making payments may be mortgage interest deductions and/or depreciation deductions. You stated you are unable to declare a loss. On top of that the property and the surrounding development will continue to lose value due to the associations’ financial problems and the damage to the properties in the development/community.
First things first, KC. You and our husband should ask yourselves the following questions?
  1. What is the impact of this investment on your cash flow? You said you are losing $150 per month. This is at least $1800 a year, $9000 after 5 years and $18000 after 10.
  2. What is the impact of this investment on your cash savings, retirement funds, IRA, or any other investment? Do you have to “dip” into your savings to pay your bills?
  3. When will a good credit score be important to you? Do you need more credit? Do you need to do anything requiring a good credit score? If so when? Will poor credit negatively affect your jobs or business?
  4. Do you understand all of the risks of strategic default? If not, please read these links – When A Homeowner Stops Paying To Get A Loan Modification and What Everyone Should Now About Debt Forgiveness, Obligations, and Deficiency and Plan to Be Followed When You Walk Away From Debt.
  5. What are your short and long term financial goals? Are you near retirement?
  6. Can you find a better use for the money?
  7. Can you get a better return if your money is put to a better use? Will the “better return” be greater than the financial cost of strategically defaulting?
  8. Do you know the time line from when you decide to stop paying a lender until a lender can successfully recover a debt? Did you know it can take a lender months or years to collect depending on the circumstances?
  9. What about the homeowner’s association? Do you face any legal risk for non-payment of monthly charges and fees?
  10. Are you prepared for the creditor harassment? Phone calls, letters, and possible legal threats? Are you prepared to fight back against this? Please refer to the Fair Debt Collections Practices Act to learn more about federal debt collection rules and regulations. There are other laws that protect you and govern the collection of debt.
  11. Did you explore all of your available options – short sale, loan modification, refinance, principle reduction, or deed-in-lieu of foreclosure?
  12. Did you know that any time the terms of a loan are changed, in any manner; it will negatively affect your credit?
  13. Did you know that a drop in your credit score may impact existing credit cards and/or loans? For example, you could see a rise in credit card interest rates or a reduction in credit card limits or home equity lines once you decided to strategically default. Check out the recently enacted Credit Card Accountability, Responsibility, and Disclosure Act of 2009.
  14. Do you know how to legally protect your assets, savings, and cash flow from creditors? Are you prepared to do so?
So to answer your question “What would you do?” depends on how you answer the above questions. Feel free to follow up with further questions after you and your husband talk.
Thank you.
Augustine Diji

Got Questions? Get Answers... KC Is Prepared to Strategically Default But Not Sure

GOT QUESTIONS?

To Whom It May Concern:

I read your website on Strategic Default and would like to put forth our situation to hear your opinion. We purchased a condo during the condo conversion craze in So. Florida in 2005. Purchase price for a 2/2 in a highly sought after area was $178,000. We put 20% and did a 7 year libor interest only. We pay our taxes separately each year. After having closed with the lender referred by the developer's sales office (Countrywide), we found out later that the association had over $250,000 in liens that were against the developer for various maintenance improvements prior to converting units and from the city for infringing on landscaping regulations. The association hired an attorney who is actively dealing with this but in the meantime, Hurricane Wilma hit and the condo association suffered tremendous damage (still has roof damage that is unrepaired). Meanwhile, we continued paying our association dues($400/mo) and additional assessments ($4000). We have lost our water and cable vendors due to inability of association to meet its debts,therefore, those costs are now incurred by condo owners (they did not reduce assoc. fee since attorney states that condos are still "underwater" with debt). The unit is now worth $71,000 according to Bank of America (I inquired to see if we qualified to refinance-they won't). In some cases, units are being bought for $30-$40K/ea by investor groups. We have totally refurnished our unit, tile, granite, new a/c, new appliances, paint, etc spending over $4000 and we can't even declare it as a loss on our taxes b/c of my husband's income bracket ($250K/yr). We own three other properties, have great credit -780 score, never have been late on a payment and have our properties rented out. In the case of the condo, we are losing about $150/month since we had to rent at a discounted price to compete with rental market. I inquired with Bank of America who assumed the condo note from Countrywide and they could not recommend any department that could qualify us for principal reduction. The only good news that may or may not happen is that the libor index may go down in July when our rate adjusts. We are willing to strategically default just because we will never recuperate our investment and the condos are falling apart (100 out of 340 units are in foreclosure). The property management company and board of directors are no help at all. The attorney is not responsive to inquiries. What would you do?

Best regards,

KC

GET ANSWERS…

Dear KC:

We agree, it is likely you will never recover your investment in the condo, so what is the point of throwing money down the drain. Your mortgage balance is about $142,400.00. This is much higher than the $71,000 value of the unit. It may be less; you said investors are paying $30k to $40k per unit. There is no positive cash flow. Your possible upside to continue making payments may be mortgage interest deductions and/or depreciation deductions. You stated you are unable to declare a loss. On top of that the property and the surrounding development will continue to lose value due to the associations’ financial problems and the damage to the properties in the development/community.

First things first, KC. You and our husband should ask yourselves the following questions?

  1. What is the impact of this investment on your cash flow? You said you are losing $150 per month. This is at least $1800 a year, $9000 after 5 years and $18000 after 10.
  2. What is the impact of this investment on your cash savings, retirement funds, IRA, or any other investment? Do you have to “dip” into your savings to pay your bills?
  3. When will a good credit score be important to you? Do you need more credit? Do you need to do anything requiring a good credit score? If so when? Will poor credit negatively affect your jobs or business?
  4. Do you understand all of the risks of strategic default? If not, please read these links – When A Homeowner Stops Paying To Get A Loan Modification and What Everyone Should Now About Debt Forgiveness, Obligations, and Deficiency and Plan to Be Followed When You Walk Away From Debt.
  5. What are your short and long term financial goals? Are you near retirement?
  6. Can you find a better use for the money?
  7. Can you get a better return if your money is put to a better use? Will the “better return” be greater than the financial cost of strategically defaulting?
  8. Do you know the time line from when you decide to stop paying a lender until a lender can successfully recover a debt? Did you know it can take a lender months or years to collect depending on the circumstances?
  9. What about the homeowner’s association? Do you face any legal risk for non-payment of monthly charges and fees?
  10. Are you prepared for the creditor harassment? Phone calls, letters, and possible legal threats? Are you prepared to fight back against this? Please refer to the Fair Debt Collections Practices Act to learn more about federal debt collection rules and regulations. There are other laws that protect you and govern the collection of debt.
  11. Did you explore all of your available options – short sale, loan modification, refinance, principle reduction, or deed-in-lieu of foreclosure?
  12. Did you know that any time the terms of a loan are changed, in any manner; it will negatively affect your credit?
  13. Did you know that a drop in your credit score may impact existing credit cards and/or loans? For example, you could see a rise in credit card interest rates or a reduction in credit card limits or home equity lines once you decided to strategically default. Check out the recently enacted Credit Card Accountability, Responsibility, and Disclosure Act of 2009.
  14. Do you know how to legally protect your assets, savings, and cash flow from creditors? Are you prepared to do so?

So to answer your question “What would you do?” depends on how you answer the above questions. Feel free to follow up with further questions after you and your husband talk.

Thank you.

Augustine Diji

Friday, April 23, 2010

Strategic Default Discussion : When A Home Owner Stops Paying To Get A Loan Modification

There is no question that the decision to strategically default is a serious one. The consequences have major financial implications for anyone deciding to employ the method. Let's remind ourselves about the primary consequences to an individual or even business that decides to strategically default:

1. A lender can sue a borrower for any unpaid amounts on a loan if the borrower defaults on a valid loan agreement. If a lender obtains a judgment for the unpaid amount, the lender or creditor may have the right to garnish wages, place a lien on a bank account or property.
2. If a lender agrees to forgive any unpaid loan amount, then under certain circumstances the portion of the debt that is forgiven may be considered taxable income.
3. A lender has the right to seize an asset that is secured by the debt after commencing a proper legal action. For example, a lender can force the sale of a property to satisfy an unpaid mortgage debt (foreclosure). A lender can seize business equipment or any other property that is pledge as collateral to secure the debt if it remains unpaid.
4. A credit score will be severely impaired for a certain period of time, thereby reducing the ability to obtain credit or a loan.

What happens if a homeowner decides to strategically default

Let's focus on a recent article titled When Strategic Default Fails by Tara-Nicholle Nelson. The author, Ms. Nelson focuses on homeowners who strategically default in order to get a loan modification. She rightly points out that lenders will not modify a mortgage loan if the loan is current. This causes a homeowner to stop paying the mortgage just to get a loan modification. Ms. Nelson believes that this creates an improper incentive for the unwitting homeowner unfamiliar with all of the consequences of strategic default.

Ms. Nelson writes: "the constant carrot of a reduced payment, reduced principal or an approved short sale of an underwater property -- no matter how illusory -- has been enough to modify many homeowners' behavior, causing lots of folks to go late just to have their workout applications taken seriously."

In other words, Ms. Nelson argues that homeowners behavior can be improperly modified to strategically default without a clear understanding of the consequences. I generally agree.

Ms. Nelson points that she has seen this behavior "create its own nasty snowball, whereby homeowners who previously planned to grow old in their home end up losing it, once their arrearages grow massive and the lender is still unwilling to bend."

Ms. Nelson continues with "[t]hink of the reward loop that is created when lenders announce they will now start reducing principal -- but only for folks that are at least two months behind on their homes. The place where behavior modification meets loan modification ain't pretty, but it is real."

You can't argue with this point.

Ms. Nelson concludes with "it's time to start reminding those homeowners who continue to pay on time that their behavior has its own rewards, including maintaining strong credit in an environment where high FICO scores are increasingly rare, and the core stability and security of knowing your home is and will continue to be yours, safe from the threat of the foreclosure that happens so often at the bottom of the late-payments-to-get-a-loan-mod slippery slope."

Therein lies the nasty side of strategic default. It certainly is not for the faint of heart. Strategic default works for some but not all. The decision to strategically default requires careful planning. It requires a full understanding of the worst case scenario.

If a homeowner decides to strategically default in order to get a loan modification or principle reduction then the homeowner must be prepared to lose their property if they don't succeed. Bottom Line.

Tuesday, April 13, 2010

Strategic Defaulters Be Aware : Lenders Will Go After Borrowers Personally For Unpaid 2nd Mortgages aka Junior Liens

The Wall Street Journal's recent report Second Mortgages Vex Borrowers by James R. Hagerty outlines lenders decision to go after borrowers for unpaid second mortgages.

There are borrowers who have second mortgages on their property. The second mortgage can be the "20" from an "80/20" loan. Essentially an "80/20" loan allowed a primary lender to lend 80% of the purchase price. A secondary lender would lend 20% of the loan price. This added up to 100% of the purchase price thereby allowing a property buyer to put very little money down. The second mortgage aka junior lien can also be a home equity line of credit ("HELOC"). Many borrowers took out a HELOC as a way to have extra cash. A borrower could draw against the HELOC when they needed cash. They turned their property into cash machine. Whether it was a "20" of the "80/20" or a HELOC, these second mortgages held a higher interest rate then the first mortgage. Furthermore, most of these second mortgages are essentially unsecured. Now that property prices values have declined significantly and property owners are "upside down", there is no way a lender can collect on the second mortgage from a foreclosure sale or short sale. There is not enough money.

The WSJ points out that according to Federal Reserve Date there are "$1 trillion of junior-lien mortgages outstanding in the U.S. at the end of 2009".

So how can lenders collect on 1 trillion dollars worth of second (junior-lien) mortgages when lenders cannot collect from the sale of a property? The lender can sue.

Understanding this is very important to borrowers with second mortgages. Basically, the lender will sue a borrower personally for the amount that is owed. Even if a lender cannot collect on a second mortgage through foreclosure or sale of the property, the lender has a right to sue the borrower personally. A second mortgage is a debt obligation that is secured by a piece of property and secured by a borrowers personal promise to pay. Please read What Everyone Should Know About Debt Forgiveness, Obligations and Deficiency to better understand debt obligations.

In the past, lenders would write this off. Lenders did not want to incur the costs of chasing a debtor. Also, lenders did not have 1 trillion dollars worth of second (junior lien) mortgages outstanding. This is a lot of money sitting on the table.

This is also big businesses. Debt collection companies are purchasing these second mortgages at cents on the dollars. For example a debt collection company may purchase a second mortgage originally valued at $150,000 for $50,000. The debt collection company can locate the original borrower and offer the borrower a 50% reduction on the $150,000. At 50% of $150,000, the borrower agrees to pay $75,000, The debt collection company offers the borrower a two, three, or four year payment plan. The debt collection company has made a tidy profit on a $50,000 debt purchase.

A lender holding a second mortgage does not have to wait until a foreclosure or sale of the property. A lender can sue the borrower anytime after a default in the payment.

Keep in mind, when a borrower decided to strategically default, in most instances the borrower has sufficient income and assets to keep paying. It is not difficult for a lender to investigate a borrower's financial profile. In other words, lenders will aggressively go after strategic defaulters since it is likely a lender will collect something instead of nothing.

There are state and federal laws that protect borrowers in certain circumstances. It is necessary to get professional advice regarding all available options.

To quote from the WSJ article, "A spokeswoman for Bank of America said that if efforts to avoid a foreclosure failed, "then we do reserve the right to recover the unpaid balance on the second lien if permissible by state law. However, our practice has been to only to pursue recovery in situations where we believe the customer has sufficient nonretirement assets to satisfy their debt obligation."

Any person considering a strategic default : Be Aware.

Tuesday, April 6, 2010

Does Fannie Mae Recognize Strategic Defaults?

The article entitled Fannie Mae Sees Strategic Default on the Minds of Underwater Borrowers by Diana Golobay of HousingWire provides some interesting messages.

The writer states: "A contagion effect within communities is leading borrowers to consider default as an acceptable option in the face of financial hardship, Fannie found. Both delinquent and current mortgage borrowers are more than twice as likely to have seriously considered stopping payment if they know someone who has already defaulted."

MY COMMENT: This is stating the obvious. Essentially a borrower decides to stop payments because its a financial strain. However, the decision to strategically default is not always based on "financial hardship", instead it is based on cash preservation and savings protection. At some point in time the federal government will recognize this.

The writer states: "Kathleen Day, a representative at the Center for Responsible Lending [said] from everything we know, no one defaults if they could possibly stay in their homes...we just don’t see people responsibly walking away. It’s people who are at the end of their economic rope.”

MY COMMENT: Once again this shows the lack of understanding behind the various reasons for a strategic default. A strategic default is all about a person "responsibly walking away."

The writer states: “The public also strongly believes in the importance of upholding the financial commitment involved in buying and owning a home, even during these challenging times when home values have fallen,” said Fannie president and CEO Mike Williams"

MY COMMENT: Ummm. Excuse me. Who is "the public"? Is "the public" the actual homeowners who own a property with a value less than the mortgage balance. It is not rational to continue to hold an asset that has a debt greater than it's worth. The "challenging times when home values have fallen" refer to an unaware property owner bleeding themselves of cash and savings while supporting a worthless asset.

The writer concludes with: “These findings underline the very large number of people whose homes are worth less than their outstanding mortgages and even larger numbers who are worried about covering their costs and expenses generally,” Harris Interactive said in the poll results. If the percentages are converted into numbers, approximately 27m adults believe they are ‘under water’ – that their houses are worth less than their mortgage debts.”

MY COMMENT: If 27 million adults believe they are 'under water' what should they do? It seems as if Fannie Mae doesn't have an answer that can help these people. That is why people are taking their financial matters into their own hands.

Strategic defaults will continue to be an important strategy for homeowners and any other debtor. Our governments seems reluctant to accept the current principles of strategic default. While understandable, it still pushes the concept that "society" must uphold its financial commitment to make payments on worthless assets thereby bleeding all cash and savings. Unfortunately, we did not hear the same call about upholding financial commitments when trillion dollar bailouts were handed out to some of the largest corporations.

It is all a matter of perspective. Perhaps the our government will come up with an effective solution. For now, homeowners and debtors alike must take their debt matters into their own hands.