Strategic Default

Foreclosure carries a stigma in our society, as well it should - normally, if you let your property go into foreclosure, it's a sign of serious financial mismanagement.  But these are not normal times...

However, some would go further to argue that you have a moral obligation to repay any loan, no matter the circumstances.

On the other hand, well respected businesses, including large corporations, default on debt all the time without the character of their boards being called into question.   Often, these defaults happen even though the corporation has the cash to pay - they have simply calculated the fall out, and decided that it makes more business sense to let a property go back to the bank, rather than throw good money after bad.

Here's an article on the practice, known as "strategic default".

Personally, I'm trying to decide who's right - I know first hand how it feels to not be paid back, as my wife and I made several personal loans totaling tens of thousands of dollars to employees and friends when times were good... and we're likely never to see the majority of that money again.

On the other hand, when a bank charges you interest on a loan, part of that interest is paid because of the risk of default - if there were no risk, the rate would be the same as a treasury bill.  So, the bank is taking the risk that you might default to make more money.  If they make the mistake of loaning money at the wrong time and property values plummet... is that the borrower's or the bank's fault?  Or is it just a risk of doing business?  Should borrowers feel morally bound to repay the debt, or should they act like a business and make the choice that protects their own interests without regard to the bank?

I'd love to hear what other people think about what to do when "strategic default" is an option for individuals and businesses.

Good faith? Lenders have forgotten the meaning...

Lenders continue to act in arbitrary fashion, making up the rules as they go along, mostly because there aren't any.  Here's a recent article on what happens when struggling homeowners try to work through the system: Banks selling homes out from under homeowners who attempt loan modifications.

My advice to homeowners in these situations would be to stop throwing good money after bad... hand the keys to the bank, make sure you have the rest of your assets protected in case the bank pursues you for a deficiency, and find a nice rental for a few years.

Of course, this only applies to homes worth much less than the mortgage amount.  Still, foreclosures have a much clearer legal course than other avenues... and you won't have to pay taxes on forgiven debt like you would with a short sale or loan modification.

Your credit will suffer more with a foreclosure - but it will also recover with time.  Credit got us into this mess, and there's no reason to think it will help get anyone out.

Selling a Distressed Property in a Distressed Market can be... Distressing.

Yes, I know the title of my post seems somewhat obvious, but it doesn't hurt to think about how to be a successful seller in a market where buyers have short sale and foreclosure fever.  If you've owned your house long enough, you can still expect to make a reasonable profit, but it's more important than ever to have your house in tip top shape before it hits the market.

First up - smells.  Even though some people think musty smells go with Beach Houses, they really are a sign that you have a leak or humidity problem.  Don't hide it with Frebreeze, find it and fix it before a buyer gets anywhere near your home.  Smell is a powerful emotional trigger, and emotions are what will motivate a buyer to pay the premium a good house deserves... clean and fresh scents are essential to keeping a buyer in a positive state of mind with regard to your property.  If a buyer wants to buy a problem... well, there might just be a foreclosure sale down the street.

I'll cover more in coming posts... and please feel free to comment with what YOU think is the most important factor to distinguish a good home from one that hasn't been maintained.

Short Sales are for Suckers!

A "short sale" is a real estate term for when a seller accepts an offer on their property for less than they owe on the mortgage.  The bank must then agree to accept that amount to release their claim on the title in order for the property to be transfered to the buyer.

What could be wrong with this?  The seller gets out from an "underwater" property, the buyer gets a house for less than the seller owed, and the agent gets a commission.

Let's consider it from each viewpoint, and dig a little deeper:

As a buyer - It's often better to wait and let the bank foreclose - then the bank is a motivated seller, rather than a third party who's only interest is to extract as much as they can from the seller.  Mortgage departments do not like to lose money, and they will play hardball to get every dime they can from the seller, while you wait, at the mercy of what the bank decides.  On the other hand, once the bank owns the property, the real estate department of that bank wants to get rid of property as quickly as possible, and will make significant price reductions on a continuing basis until the property sells.

As a seller - with an "underwater" property, you have a bad hand no matter how you play it.  To qualify for a short sale, the bank will only be interested if you are behind on your mortgage (why would they take less than they are owed otherwise?), and once you are behind on your mortgage,  your credit will be nearly as bad as from a foreclosure.  To make matters worse, the bank will require full disclosure of whatever assets you have, and if they decide to sue you for a deficiency later, you have no way to protect what assets you have left.  If they do in fact forgive the debt, then you risk having a gain reported to the IRS on the amount they forgave.

Sellers and homeowners - if you are significantly under water, find an attorney, and go from there. Don't wait, whether you are selling or not.  If you own any other property, a visit with a good attorney may be the only way to save what assets you have left.

As an agent - you stand a good chance of losing a perfectly good buyer if the bank decides to play hard ball. They will be stuck in a waiting game, and you will suffer if they end up frustrated, waiting for a property that may or may not be approved for a short sale by the bank.  What are the chances that buyer will continue with you if the sale falls through and they've wasted months of effort? 

If you are listing a property where the mortgage exceeds your recommended price... counting on a bank to approve a short sale in the future puts you at risk of wasting marketing resources, and puts your seller at risk for the aforementioned reasons.  If your seller is unable to convey clear title at the current market price... they should be talking to an attorney, not you.

When I first started in real estate, 15 years ago after the last boom and bust, some of my first listings were bank owned properties.  They were not in good shape, and it took buyers that could literally hold their noses... but they sold at significant discounts to the already depressed market.  I still think about that double lot on Va. Dare Trail with a huge house that sold for $110,000 back in '95...

I'm sure there are many agents out there who will disagree with me considering the short sale hype and training programs I've heard about... so please, share your thoughts in case I'm missing something.