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.