Strategic Default Monitor – How To Strategically Default

Friday, September 3, 2010

Strategic Default Monitor - Recent News Updates - September 1, 2010


An article like the following cannot go unnoticed, unread, and un-commented upon. MSNBC.com reports on Homeowners Feeling The Pressure From A Life 'Underwater'.  The article talks about a homeowner who is "doing what millions of Americans are doing these days: He's getting used to living life 'underwater' - the real estate industry's term for a property worth less than the outstanding mortgage on it".

From the perspective of any person considering a strategic default, there are two main points in the article to consider:

1. The homeowner interviewed in the article has a good job and can afford to make payments, however he cannot tap into any equity. He purchased the property with 100% financing. On top of that he is illegible for a loan modification because he makes to much money. My thought: Why not provide a principle reduction to home owner's willing to make mortgage payments on an upside down property. 

2. The homeowner admits to being tied down to the property. However he  moved into the basement to rent the two bedrooms in his home. His goal is to use the extra money to reduce the principle balance of the mortgage. My thought: This homeowner has found a creative way to regain equity so he can become "untied" from the property. He is also preserving his good credit in hopes of getting a loan or refinance in the future.The only questions are: can he create equity faster than the current decline of property prices? and will good credit matter if he does not have cash for a down payment or if lenders continue to restrict lending? Only time will tell. 

This next article firmly establishes that business minded investors are strategically defaulting in order to get a better deal. Wall Street Journal Online reports that Commercial Property Owners Choose To Default.

Now, of course, this is old news. Businesses have always used a strategic default when it is in its best financial interest. Businesses generally do not have moral constraints. Yet, this recent article establishes that strategic default is growing simply because assets (in this case real estate) are worth less than the debt secured by the asset. Most importantly, the article illustrates why homeowners and small real estate investors should seriously consider strategic default. 

The article begins "Like homeowners walking away from mortgaged houses that plummeted in value, some of the largest commercial-property owners are defaulting on debts and surrendering buildings worth less than their loans."

My thought: One should not overlook this comparison by a major business publication. 

"Companies such as Macerich Co., Vornado Realty Trust and Simon Property Group Inc. have recently stopped making mortgage payments to put pressure on lenders to restructure debts. In many cases they have walked away, sending keys to properties whose values had fallen far below the mortgage amounts, a process known as 'jingle mail.' These companies all have piles of cash to make the payments. They are simply opting to default because they believe it makes good business sense."

My thought. It should be understood that lenders handle strategic defaults on commercial loans differently from residential loans. In other words, a strategic default on a commercial loan has a better chance of forcing a lender to make a deal than a residential loan. At the end of the day the decision is purely financial. It is more likely a lender will collect from a commercial loan modification than a residential loan modification. That being said one cannot ignore the hypocrisy of it all. Several weeks prior Fannie Mae announced that it would punish homeowners who strategically default. In fact, our government has been seeking do the same thing. WHY DON'T THEY PUNISH COMMERCIAL PROPERTY OWNERS. 

"These pragmatic decisions by companies to walk away from commercial mortgages come as a debate rages in the residential-real-estate world about 'strategic defaults' when homeowners stop making loan payments even though they can afford them. Instead, they decide to default because the house is 'underwater' meaning its value has fallen to a level less than its debt.  Banking-industry officials and others have argued that homeowners have a moral obligation to pay their debts even when it seems to make good business sense to default. Individuals who walk away from their homes also face blemishes to their credit ratings and, in some states, creditors can sue them for the losses they suffer. But in the business world, there is less of a stigma even though lenders, including individual investors, get stuck holding a depressed property in a down market. Indeed, investors are rewarding public companies for ditching profit-draining investments." 

My thought: This represents a turning point in the argument against home owner's strategically default. No matter how one reads the prior quote from the article there is one inescapable conclusion. It will no longer be possible to separate the accepted practice of strategic defaults by big business, commercial investors, and our government from strategic defaults employed by consumers. Therefore, it is unlikely Fannie Mae's attempt to punish strategic defaulters will work. It is unlikely that any rule, regulation, or law to limit or prohibit a strategic default by a citizen will ever be effective and most importantly, it is unlikely an such rule or law will ever be legal.

For those who are considering a strategic default. Rest assured that if a strategic default makes sense, you will always be on solid footing.

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