60 Minutes did a piece recently on “Strategic Default” and highlighted the modern problem of people choosing to walk away from their home.
What is strategic default?
In layman’s terms, a strategic default is a homeowner letting their house go to foreclosure even though they can make the payments. They strategically choose to let the house go to foreclosure. Part of the logic is that they don’t want to pay anymore for a house that they feel will never get its value back again and they can go out and rent for a while and then buy a much cheaper house at market prices.
Is this something that makes sense?
Anybody considering this course of action should probably take a step back and get together with some professionals to investigate how this is going to affect you:
- Real Estate Attorney: what are the laws in your state regarding default and how is this going to affect you?
- CPA/Accountant: you have the potential of have severe tax ramifications when you walk away from your home. There is such a thing as cancelled debt and the IRS looks at this as income.
If you make this type of decision without doing your homework, you’re just going to get hurt.
Strategic Short Sale
A strategic short sale might be a better option for you considering that in this process you’re mitigating tax and credit repercussions:
- Credit: A foreclosure is damaging to your credit and will stay on there for at least 7 years. How does this fit in with your lifestyle moving forward? The short sale credit impact will be modulated by late payments and short sale reporting which can be negotiated with the lender. At the end of the day, it’s an account that you settled instead of a foreclosure that is reported.
- Job: Nowadays employers run background checks on potential employees on which they base their hiring decision. If you are in a secure job, this is probably not going to affect you.
- Negotiated debt versus charged off debt: A second lien position is most likely going to be a HELOC (home equity line of credit). A charged off HELOC is going to be sold to a debt collection company and these guys are going to hound you for a while and potentially get a judgement on you if you have assets and/or have a decent salary.
- Taxes: you’re potentially going to pay taxes on the difference between what you owe and what the lender can recuperate via either foreclosure or short sale. In a foreclosure situation the amount of cancelled debt is going to be larger than in a short sale situation. Do you really need to be owing the state tax board or the IRS more if you can help it?
- Buying a home: A short sale drastically reduces the time that you’ll be able to get a new loan again. Best case scenario you can buy a home again after 2 years (conventional financing). With a foreclosure, you’re looking at at least 5 years.
Conclusion
Consult with an attorney, CPA, short sale realtor, etc. before you decide to do anything as drastic as a strategic foreclosure, because you might find out that a strategic short sale is better suited for you. Banks don’t care about you so do what’s best for yourself. Make a decision based on knowledge and keep moving forward. Don’t let emotions drive you into decisions you will regret. The CBS piece is below:
