Strategic Defaults: Why Homeowners Choose to Lose Their Home Instead of Selling or Renting Out

The concept of strategic default became particularly relevant during the 2008 U.S. housing crisis. It often involves homeowners choosing to stop paying their mortgage and allowing the bank to take possession of the property, rather than selling it at a loss or renting it out until they can afford to buy another home.

Legal and Social Factors Influencing Strategic Defaults

Decisions to strategically default are complex and vary based on individual circumstances and the laws of the state or country in which they reside.

Personality and Decision-Making

Strategic defaults often stem from tough and complex decisions that can be paralyzing. Many people, possibly most, find themselves overwhelmed by the financial and social impacts of their choices. The fear of losing their house can lead to a freeze in decision-making, resulting in inaction and, ultimately, default.

Eviction and Legal Processes

The process of eviction or foreclosure can be slow and complicated. This is especially true in some states where the eviction process can take years. In recent times, evictions have been further delayed due to pandemic-related moratoriums on evictions, which, when lifted, bring prolonged periods of unpaid mortgage or rent.

In some jurisdictions, evictions can take literally years. The bank must sue the homeowner, obtain a court decision, reduce that decision to judgment, and then wait for the sheriff to enforce the judgment. For example, a person evicted in March 2020 might not face physical removal until now, almost three years later, due to ongoing eviction moratoriums.

Legal Responsibilities and Foreclosures

Foreclosure rules and laws significantly influence whether a strategic default is economically viable.

No Recourse and Recourse Jurisdictions: Some states and countries are known as “no recourse” jurisdictions, meaning homeowners are not responsible for the shortfall between the sale price and the remaining loan balance. In contrast, “recourse” states hold homeowners responsible for the difference. For example, if a property is foreclosed on and only sells for 200,000 dollars while the remaining loan balance is 500,000 dollars, the homeowner in a recourse state would still be liable for an additional 300,000 dollars.

Renting and Market Dynamics

There are different laws and rental market conditions across various regions. Some areas have strong rental markets, which can offer more financial stability than trying to quickly sell a property at a loss. However, the decision to rent versus strategically foreclose depends on the specific market conditions and individual circumstances.

Case Studies and Real-World Examples

Consider a case where a homeowner in a no recourse state finds themselves owing 150,000 dollars based on a second mortgage. If the homeowner chooses to strategically default, the bank would take the property, but the homeowner would not be responsible for any additional debt beyond the relinquished property. However, in a recourse state, the same scenario could result in ongoing legal battles and financial liabilities.

Ethical Considerations and Alternatives

Strategic default is often seen as an ethical dilemma. For those who strategically default, there are significant negative consequences such as damage to credit scores and potential legal issues. However, these consequences must be weighed against the lesser of selling a home at a large loss or renting it out while grappling with financial hardships.

Alternatives to Strategic Default

There are alternative strategies available to homeowners facing financial difficulties:

Refinancing: Some homeowners might explore refinancing their mortgage to lower interest rates and reduce monthly payments. Forbearance Plans: Banks can offer forgiveness or rescheduling of missed mortgage payments to avoid default. Short Sales: In some cases, a homeowner might consider a short sale, where the property is sold for less than the remaining loan balance. Bankruptcy: Filing for bankruptcy can provide a temporary moratorium on foreclosure proceedings and may offer other debt relief measures.

Conclusion

Strategic defaults are a critical topic in the field of real estate law and finance. The decision to strategically default is influenced by a combination of financial, legal, and personal factors. Understanding the nuances of mortgage laws, the potential impacts of strategic defaults, and exploring alternative options can help homeowners make informed decisions and navigate the complexities of financial distress.

Keywords: strategic default, mortgage default, foreclosures, no recourse, mortgage states