TM Is In A Classic Strategic Default Conundrum, What To Do? What To Do?

GOT QUESTIONS?

Hi there,

I'm in the Bay Area of California (West Oakland, a low-moderate income  neighborhood, changing slowly, but centrally located & surrounded by well-established neighborhoods).  I bought my first and only home, a fixer upper, in August 2005 for $430K.  It's currently assessed, by the county, at $142K, although I seriously doubt it would even sell that high. I'm betting $125 max.  I had put $120K down initially, and have put in another $80K for rehabs. so far.  It needs another $85K or so, which I currently have in savings.  Moody's analysis predicts the market won't rebound til 2020 at the earliest for my area, but I need to sell at $510K at current investment just to break even, or $600K if I finish the work.  It'll be a long time, if we can reach that goal at all, if I am to take stock in Moody's analysis. (I'm 40).

I need to explore my financial options with regards to this house: finish the work and take a gamble on the future, or walk away from the house with a strategic default and lose $200K.  I don't qualify for a loan modification under current moderate income-level limits: my lender is Cal HFA (at the time that I bought it, I qualified for a 4.75% fixed rate loan in the moderate income category, but my income has since increased to slightly past the eligibility limits for loan modification under the anticipated extension of the Keeping Homes Affordable program.  Plus, I can afford my payments).  I don't qualify, that I'm aware of, for a short sale for the same reason: I can afford my payments.  But the question remains: is it worth it to finish fixing the house and take a chance at breaking even in the long haul? Or would I just be throwing good money after bad?

I'm trying to figure out who best to consult with in order to further explore this question, given all of the particulars of my situation. Would I consult with an accountant?  Are there accountants with expertise in real estate?  Is there some other professional I should consult with?

Any thoughts, leads, advice, etc. would be welcome...

thank you

GET ANSWERS…

Dear TM:

First of all thank you for writing to me.

The first question is to ask yourself what are you goals? How long do you want to keep your home? How long will it take for your property to increase by $475,000 so you can reach the $600,000 price point? You have a fixed rate loan, so over time your monthly payment will reduce principle. So if you plan to be in the house for the next 15 to 20 years then your principle will be reduced. By your 15th year, more of your monthly mortgage payment will be applied towards principle than interest. You can review an amortization table to determine how your monthly mortgage payment will be applied against interest and principle.

You need to ask yourself if an investment of $85,000 into the repair of your home will give you a better return than any other investment? What is the best use of your current savings? You are right, if you strategically default you will likely lose your initial $200,000 investment in your home.  

That being said let’s review the risks of strategic default. You need to understand your risks to make an intelligent decision.

The primary risks of a strategic default are:

1. Deficiency debt leading to a deficiency judgment. This includes a lender deciding to sue for the entire outstanding debt instead of filing a foreclosure action.
2. Lower credit score.
3. Loss of the home or property to a foreclosure sale.
4. 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 it is proven that a person strategically defaults. Read this  link to learn more.
5. 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. Read this link to learn more.

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 debt also known as debt deficiency arises when collateral that is used to secure a loan cannot satisfy the total amount due on the loan. The unsatisfied amount due on the loan is a deficiency debt. Read this link to learn more about deficiency debt defense.

You mentioned that your property is in California. California is a non-recourse/anti-deficiency state. That means a lender may not have the right to seek a deficiency judgment. Please read this link 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. Under current Federal Law if a debt is forgiven on a primary residence then there is no tax due to the IRS. Read this link to learn more.

You have the right to request a principle reduction. You may not need to default to request a principle reduction. Contact the lender.

You can negotiate a deed-in-lieu. This 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.

You can negotiate a short sale. You may not have to be in default to negotiate a short sale. The key is proving to the lender that you are unable to sell the property without a short sale. The lender may request that you list the property for sale. However in your case, an appraisal or a broker’s opinion should be accepted as a substitute for listing the property.  You will need to speak to the lender.

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. 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?

So think carefully. You should focus on California’s non-recourse/anti-deficiency laws.

You should consult with an attorney regarding the legal risks of strategic default, especially regarding California’s non-recourse/anti-deficiency laws. You need to ensure that under California law you will not be exposed to a deficiency. You also need to consult with an accountant to ensure you will not have any tax related issues regarding a strategic default and the forgiveness of any debt.   

Please contact me with any further questions. Good luck.

Thank you.

A. A. Diji