Strategic Default? Is it Really the Best Alternative?

I am sure that you have seen in the news about people giving up their homes as a "stretegic default". You may also be aware that people who lose their principal residence in foreclosure will not be responsible for taxes for the normally taxable event of a "loss forgiveness". When contemplating a "strategic default" homeowners can presently afford the home in which they are living but decide not to pay. They take the money that would be used for a mortgage payment and choose to put the money somewhere else that would be protected by the laws of the state. In Florida, that could include retirement plans, trusts, life insurance policies, or even another home. They may be protecting the assets but they may not be protecting themselves from personal liability. Eventually, the home will be foreclosed (probably more than a year in Florida from time of default to foreclosure sale). I will use the example of a $250,000 mortgage on a home that is now worth $125,000. Once it is foreclosed, the mortgage company will potentially have a "deficiency" of $125,000. If the foreclosure was completed prior to December 31, 2012 (this may again be extended by the new Congress), the deficiency balance, or loss forgiveness will not be taxable. However, this does not mean that the bank (or, the subsequent owner of the note) will not be able to pursue the homeowner for the balance. In a stretegic default, the homeowner would have been able to live "rent free" for at least 12 months. Assuming a mortgage payment of $2,000, they would have been able to save $24,000.00. But, after the foreclosure, they would still have a potential debt of $125,000.00. It is important to be aware that the bank will have five years (in Florida) from the sale date to pursue the $125,000 plus interest and cost. It is the fear of many bankruptcy attorneys that clients will choose to walk away from their home, forget about the potential liability and five years later be faced with a lawsuit. There are better options. Homeowners can choose between a "short sale" or "Deed in lieu of foreclosure". With a short sale, the homeowner puts the home up for sale at the market rate. The property must be advertised as a short sale and state that it is subject to the bank's approval. Once a buyer is found, the contract is presented to the bank for approval. There are a lot of internal unknown reasons for a bank to consider a short sale. The bank will not approve a short sale if the property is not being sold for "market value". Why they would reject a short sale is a mystery. As part of the short sale, the bank may require the financial records of the homeowner. A deed in lieu of foreclosure merely means that the homeonwer is giving the property back to the bank without the bank having to go through the foreclosure process. A Deed in lieu of foreclosure is usually unavailable if there is a second mortgage on the property. If there is a second mortgage, the second mortgage holder will have to approve the transfer as well. (If the first mortgage and second mortgage are held by the same bank, it does not mean it will be approved.) A bank will not likely accept a deed in lieu unless the homeonwer has taken efforts for at least six months to market the property. Many times the bank will forgive the deficiency indebtedness in the situation of a short sale or deed in lieu. But, it may be subject to the bank's review of the homeowner's financial records. If you have any question, please contact me at brian@bkmbankruptcy.com.

What About My Credit Score?

It seems that many Americans are more concerned with their credit score than their net worth. I have many clients that have $50,000 or more in credit card bills that are more worried about how bankruptcy will affect their credit score than they are with getting rid of the debt. Each month they are paying $1,000.00 per month or more to pay off credit cards. They are killing themselves with worry and stress to pay this debt. They aren't working for retirement or a financial future but instead are working to pay debts.

As I have stated before, I think bankruptcy should be a last resort. There should be a plan to get out of debt before resorting to bankruptcy. But, if it is impossible to pay off the debt due to income limitations or illness, bankruptcy is a very good financial option. It is certainly better than being a slave to your debt.

How will bankruptcy affect your credit score? It will affect it between 100 and 200 points. Now, we've got that out of the way, what does it mean? Bankruptcy stays on your credit report for 7-10 years. However, once you obtain your discharge in bankruptcy, you can begin to rebuild your credit.

As you make each car payment and each mortgage payment, you are rebuilding your score. When looking at your credit score, examiners will see higher income and low debt levels (debt to income ratio) because you have just discharged your debt in bankruptcy.

While rebuilding your credit score will take time, rebuilding your life will be easier.