As the recession has deepened and lengthened, many people who are fully able to afford the payments on their real estate loans on over-encumbered property have decided to walk-away and let the property go to foreclosure. For these people, the long time it would take to reach break-even simply doesn’t make financial sense. This practice has come to be called “Strategic Default”.   While the rights of the affected lenders will still be solely governed by the loan documents, as expected the lending industry is pushing for stronger penalties to curtail Strategic Defaults.

As reported widely on the web, Fannie Mae (”FNMA”), the government-sponsored enterprise that creates the “secondary market” by buying up mortgages, has stated that: “Defaulting borrowers who walk away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure”.  We had previously reported that both FHA and FNMA were talking 5 years for this practice so we are not surprised at this announcement.

More worrisome is the FHA Reform Act (HR 5072) which was passed by the House of Representatives with nearly unanimous consent and is now being debated in the Senate. The proposed Act contains a provision that would bar strategic defaulters from getting an FHA loan any time in the future!  This Bill was supported of course by the lending lobby, but also by the National Association of Realtors and even by that  champion of the common man, Barney Frank.  Will it pass through the Senate? Almost certainly although it’s final form remains to be seen. While the overall objective of the Act is to save the financially-damaged FHA through raising the costs of mortgage insurance, this provision is obviously targeted at stopping the practice of strategic default. 

What remains unclear despite all the hype is how to define who exactly is a Strategic Defaulter.  While obviously a person with plenty of assets and financial capacity who defaults as a business decision would seem to fit the description, that may be more the exception than the norm. More common is the person, as reported in the Washington Independent http://washingtonindependent.com/88445/strategic-default-penalties-threaten-struggling-homeowners, that suddenly realizes that they have been sinking steadily and if they don’t stop now they’ll lose everything.  Should that person be barred forever?  Of course not. What will most likely come out of this is a recommended process that upside down owners should always follow: First seek modification; then seek short sale; and only last let it go to foreclosure. For the borrower with financial capacity, the outcome may be the same but the process may infuence future borrowing ability.  Of course, if there is actual deficiency liability on the loan, the financially solvent borrower may not want to disclose their assets to the lender through a modification or short sale since this would certainly invite a demand for contribution or even for a judicial foreclosure (in California).

Lastly, there is the very real question of whether targeting strategic defaulters is fair and equitable. The loan being defaulted is a contract between the borrower and the lender that already provides remedies that the lender can take if a borrower defaults.  Both borrower and lender take on the known risks of what will happen on default. Why should government intervene in this contract to give the lenders even more remedies by effectively increasing the borrower’s risks?  Certainly the government has refused to effectively intervene to protect borrowers from the extraordinary risks in the sub-prime loans promoted by the lenders through 2007.  Meanwhile, the HAMP modification program hyped to help homeowners limps along with only 4.5% getting permanent modifications and virtually no-one getting principal reductions. 

Millions have lost their homes with no realistic assistance from the government and now this Act will not only further hurt future borrowers but will once again send a very clear message that as far as Congress is concerned, what’s good for the lenders is good for the country.  If you believe that this provision of the proposed Act should be dropped or changed, be sure to write your State Senator and make your concerns known.

The information presented in this Article is not to be taken as legal advice. Every person’s situation is different. If you are considering default on your loans, get competent legal advise in your State immediately so that you can determine your best options. 

If you have specific questions about your liability in California or about short sales, foreclosure, or any legal issues, feel free to contact us at sjbeede@bpelaw.com.  We offer a $200 flat fee consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-966-2260.