I got a chance to watch a couple of agents go at it with each other in a real estate forum trying to answer a question about doing short sales.   It was interesting, to say the least.  Besides the two main agents who proclaimed themselves the “experts” and hijacked the conversation, there were a few others who chimed in and made some comments.  But the question was never specifically answered.

The question posed was whether a lender will approve a short sale if the borrower had assets. He didn’t provide a lot of detail but wanted to either do a short sale or let his home go into foreclosure and he specifically asked not to get into a debate about the ethics in not paying his mortgage.

The argument or “discussion” in the forum quickly evolved into a big debate about the ethics of what people considered to be strategic default.  One expert proclaimed it was morally and ethically wrong to engage in strategic default and the lenders would not go for it. The other expert proclaimed morality and ethics had nothing to do with his decision and it was more about money.

As a San Jose Short Sale Agent, I tend to agree with the latter expert.  When you are dealing with short sales with lenders, the department you deal with is called Loss Mitigation.  Let me say it again:  Loss Mitigation.  Their job description is patently obvious: it is to mitigate or lessen the loss for the lenders.

Yes, there obviously are moral and ethical implications of not paying your mortgage when you have the financial ability to do so.   I firmly believe you should pay when you can and live up to your contractual obligations.  However, the question posed specifically asked not to judge the ethical implications but sought opinion as to whether a lender would agree to a short sale when the borrower stopped paying and was headed towards foreclosure.

There is no definite yes or no answer in these matters as the answer lies in the details.  It has a lot to do with how much assets the borrower has or does not have.  However, if the lender is faced between foreclosure and short sale, from my experience, the loss mitigation department chooses short sales over foreclosures.   At the end of the day, the primary decision will be about which method loses less money for the lenders, then, other factors like ethics and mortality can be entertained.

Why do you think big lenders like Chase and Wells Fargo are offering people up to $35,000 to do a short sale without even verifying their financial information?   HAFA recently amended its rules to state that servicers are no longer required to verify any financial information, but only to collect signed hardship letters.  Do these actions by large lenders and servicers sound like they are overly concerned about the ethical or moral issues surrounding foreclosures?

I can’t speak for other States, but in California, the recent changes in the law means if the lenders agree to permit a short sale, then the issues about deficiencies become null and void.  Once a short sale has been approved, the seller can walk away clean without looking over their shoulders.  Yet, another procedure that make completing a short sale more effective and efficient and preferable to foreclosure.  It’s all about money; if the institutions can make more money foreclosing, they will certainly choose that method, but everything recently is geared towards choosing short sales.  Yes, the lenders hate strategic defaulters, but they hate losing money even more.

So back to the question about would a lender approve a short sale if the borrower has assets?  It would depend on how much assets the borrower had and whether foreclosure would yield more money for the lender or a short sale.

More and more people are talking about Strategic Default and the more people talk about it, the more nervous and angry the lenders become. This is a situation where the homeowner has the financial wherewithal to make the payments, but simply choose not to.   The homeowners are choosing to go into foreclosure voluntarily, presumably because they came to the conclusion it was better than keeping the property and paying the mortgage.

Contrary to popular belief floating out there in the internet world, there are consequences to walking away.  And the lenders are trying to make it more onerous on those who they identify as strategic defaulters.

The single biggest consequence to homeowners is the harm to their ability to borrow money in the future.  Yes, the homeowners can walk away and let the house foreclose, but that does not mean that the lenders will take it lying down.   Once the homes foreclose, the homeowners  will have to answer “Yes” on their future mortgage applications (form 1003) or other loan applications when asked if they had ever been a party to foreclosure.  These defaulters will be tagged as greater risks, so the cost of obtaining any type of consumer loan products will be higher with this item tagged on their credit histories and it will take longer to get this derogatory item off their credit reports.   Huge opportunity costs involved here.

Another cost is the deficiency claim that the lenders will most likely preserve.  In California, if the homeowners have two loans, the junior lien holder will most likely preserve their deficiency claim after a foreclosure.  Because the homeowner simply walked away from the loan, the lenders will preserve their claim to the loss they endured.

Effects on future employments is another consequence to bear in mind.  More and more employers are doing checks on credit reports prior to hiring new employees.  In these days of 10%+ unemployment rate, these homeowners do not want to give the employers any reason to gloss over their resumes and pass along to the next applicant.

Homeowners should not simply walk away from their homes.  Seek out other alternatives.

The general perception is that the people who are not paying their mortgages are either unemployed or are the common man who is going through a rough time.   This headline, however, paints a bit of a different picture: it is the borrower of  loans that are over a Million Dollar who are defaulting at a higher rate than the borrowers below a Million Dollars.  One in Seven for the Million Dollar borrower versus one in twelve for the other borrower.

The talk of the moment right now is that of strategic default.  And the interesting thing is that this article raises the question as to whether the rich are making strategic financial decisions to stop paying their mortgage as bad investments.   That certainly would explain why the segment with the higher net worth and other resources are defaulting at a higher rate that the less fortunate segment of society.

It would be interesting to see how this pans out.

Today, Fannie Mae announced how it would deal with strategic defaulters: they will be punished by being unable to qualify for a loan for up to 7 years through Fannie Mae and the latter will reserve the right to take legal action to recoup the losses in states that permit deficiency judgments (not the case in California).  The line has been drawn in the sand.

Strategic defaulters, or those borrowers who have the financial ability to pay their mortgages but who choose not to and walk away because the value of their homes are underwater, are becoming a big problem for banks as the stigma is becoming less and less meaningful and the distressed properties market is ever increasing.   One study puts strategic default at 1/3 of all defaults which eventually lead to foreclosures.

Fannie Mae is addressing a big problem for itself and trying to force strategic defaulters to think twice before walking away from their mortgage obligations.  It’s a perfectly understandable move on its part as it is trying to do potential future damage control.   This reason is also why it has agreed to participate in the HAFA program guideline to encourage negotiated and approved short sales rather than have homeowners simply walk away. Fannie Mae and Freddie Mac have figured out it is better to work with the distressed borrowers and, for those who qualify, work out an agreed short sale resolution rather than have the property foreclose, as the loss to them will be significantly greater in the end. They are simply engaging in good business practices by mitigating their loss.

You may have heard that a “strategic default” can be an appropriate and even beneficial reaction to an upside-down mortgage or impending foreclosure. While this idea is widespread, the truth is that default is never an easy road to choose, and rarely ever strategic.

Unfortunately, the ramifications of a “strategic default” are rarely explained, leaving many homeowners stranded on an island of misinformation. To assist you, I’ve prepared a free report outlining the myths and misrepresentations of strategic defaults.

Fill out your information below for this free report. Don’t hesitate. Get the facts today!