Firstly, I want to thank you for your site which has provided some invaluable insight into the possibility of strategic defaulting.
My husband and I have been challenged by the recent downtown in the housing market. We have a home (on which I’m the primary, my husband the secondary borrower). We also have condos each (each of us are primary borrowers on one of them). The home is now worth $300,000 less than the $1.2million we paid for it (and $100,000 less than our mortgage). The condos are worth approximately half of the $600,000 we paid for them. I have just lost my job, and job prospects look bleak for me at this time. My husband is working, but cannot cover all of the mortgages.
We have been considering strategically defaulting on all of the properties and moving into a rental property and simply cutting all our losses (effectively starting again). We have also considered strategically defaulting on the home and living in one of the condos (we think this I the better solution). My husband could pay the mortgages for both condos, they are not in a location which can be rented. We’re concerned about the ramifications of such an action however, we are sure that at this point, we must lose at least one of the properties we are making mortgage payments on.
We realize we are in a recourse state (GA). How will my being first on the note affect my husband who is second? Any deficiency awarded against me solely at this point cannot be satisfied as I have no income. As my husband is the only one who is working, how likely is it that any such deficiency will be garnished against his wages?
Thank you for any help you can provide.
DF, thank you for contacting me.
First things first. You and your husband are equally liable and equally responsible for the mortgage loan if you signed the note and your husband signed the note. I am being specific about the note not the mortgage. A lender or creditor will not differentiate between who signed the note first or last, as long as it has been signed by each party. The note a.k.a. promissory note gives a lender the right to collect all of the money from any person who signed the note. A note is evidence of a loan of money. A mortgage is a security lien against the property. A mortgage is not a promise to pay money.
The primary risk of a strategic default is a deficiency debt. The other risks are:
1. Lower credit score.
2. Loss of the home or property to a foreclosure sale.
3. Recently, Fannie Mae implemented a rule that bans a person from
obtaining a Fannie Mae mortgage, if that person strategically defaults. The ban last for seven years. Furthermore, the United States Government may pass a law that bans a person from obtaining a government insured loan, if that person strategically defaults.
4. Debt collections tactics, including mail, letters, personal visits to the
property, phone calls to cell phone, work, and/or family members. Not all debt collection tactics are legal. You should become familiar with your state’s debt collection protection laws and the Fair Debt Collections Protections Act.
However, my experience has established that most people who strategically default are most concerned about deficiency debt. Most people do not want to be chased down for more money by creditors or lenders.
Let’s go through deficiency debt issues carefully.
A deficiency judgment is an unsecured money judgment against a borrower whose mortgage foreclosure sale did not produce sufficient funds to pay the underlying promissory note or mortgage loan, in full.
You mentioned that you live in a recourse state. You appear to understand that a recourse state allows the lender or creditor to seek an unsecured money judgment for any deficiency. Also, a deficiency judgment has a time period. In some states a deficiency judgment can last up to 20 years. So even if you have no income now, you may have income in the future. Read this link about Recourse and Non-Recourse states to learn more.
If a lender or creditor forgives the deficiency then you will not be exposed to a deficiency judgment. When a lender or creditor agrees (IN WRITING) to forgive a debt as opposed to seeking a deficiency judgment, then the forgiven debt may be considered income by your state taxing authority and the IRS. Forgiven debt is income.
Now consider this. Under current Federal Law if a debt is forgiven on a primary residence then there is no tax due to the IRS. However, this rule may not apply to state tax law.
Read about debt obligations, deficiency, and forgiveness so you can better understand everything that I have written so far.
So, if you consider strategically defaulting on your (primary residence) home AND you can negotiate debt forgiveness with your lender, then you will not have any exposure to a deficiency judgment and you will not have any federal tax liability.
The question is What Does It Take To Get The Lender To Agree To Forgive Your Debt?
The answer is: you must successfully negotiate a principle reduction, short sale, or a deed-in-lieu of foreclosure AND get the lender to agree (IN WRITING) to forgive any deficiency. You want the creditor or lender to give up its right (IN WRITING) to seek a deficiency judgment.
A principle reduction is when a lender or creditor agrees to reduce the principle balance of a loan.
A deed-in-lieu is when you enter into a written agreement to give the property back to the bank. The key is to negotiate a full settlement of your total outstanding mortgage debt including fees and penalties in exchange for the deed to your property. A full settlement of your total outstanding mortgage debt eliminates a deficiency and tax liabilities. A partial settlement still leaves open the possibility of a deficiency judgment or forgiveness of the remaining balance.
A short sale occurs when a lender let’s you sell your property for an amount less than what is owed on the mortgage. Essentially your lender may be willing to accept less than the full amount due on a mortgage. If you owe the lender $400,000 then the lender may agree to let you sell the property for $350,000.
In all the above cases you must get the lender to agree to forgive the deficiency.
Beware of the Turn In Your Financial Documents Trap. This happens when the lender’s representative asks you to turn in your financials via telephone or fax in order to see if you qualify for a loan workout, principle reduction, deed-in-lieu, or short sale. Before you agree to turn over your financial documents ask the lender to send you something in writing stating that they will seriously consider a work out option if you turn over your financials. Or ask the lender to direct you to their website regarding their loan workout processing rules. The problem I have is this: What happens to your financial documents, if your lender refuses to negotiate a loan workout? Can the lender use this information against you? For example, can the lender use the information during a foreclosure action or during a lawsuit seeking a deficiency judgment? In order to collect on a properly obtained deficiency judgment, the creditor or lender must locate your bank account, or locate your investment account or locate your place of employment or locate any other asset that has value. I don’t think anyone wants to turn over their financial documents to be used in any way to take their money.
If you do decide to turn over financial documents to the creditor or lender, then cross out all of the account numbers. If the creditor or lender refuses to work with you after you have turned over your financial documents then immediately move all of your money and your investments to another financial institution.
A creditor or a lender has the right to garnish wages if it properly and legally obtains a deficiency judgment in a court of law against a person who entered into a legal loan agreement with the creditor or lender. So yes, your husband could be exposed to wage garnishment if the creditor or lender successfully obtains a deficiency judgment against him.
Keep in mind that even if a creditor or lender successfully obtains a deficiency judgment, it does not mean all is lost. You can negotiate a settlement with the creditor or lender. The creditor or lender may take 50% or less than what is owed instead of spending time in court. Also keep in mind to NEVER LET A LAWSUIT FOR A DEFICIENCY JUDGMENT GO UNDEFENDED. NEVER IGNORE THIS TYPE OF LAWSUIT. The simple reason is that you may stop the creditor or lender from getting a judgment or you may be able to use your defense to this lawsuit as a means to negotiate a settlement.
You should seriously consider working with a qualified attorney and/or accountant in order to understand your specific risks.
You have to make some difficult choices. I am confident that once you understand you options you will get through this successfully.