Thursday, June 24, 2010
Seven Year Penalty for Strategic Default
Strategic default is often defined as the conscious decision of a borrower to stop payments on an otherwise affordable mortgage because the property is worth less than the mortgage balance.
The recent trend of strategic foreclosures has sparked concern and action on the part of Fannie Mae. In an effort to curb such default, Fannie Mae stated on Wednesday that it would "lock out" homeowners from receiving a new loan for a seven year period if it is determined that the borrower is guilty of strategic default.
The lock out period replaced the previous five year period adopted in 2008. Unless a borrower can demonstrate extenuating circumstances through documentation or show a good faith attempt with the lender to avoid foreclosure, the borrower will not be eligible for a new Fannie Mae for at least seven years. Other lenders, such as Freddie Mac, also punish defaulters with lesser lock out periods.
In addition to the new "lock out" plan, Fannie plans to more aggressively pursue deficiency judgments by executing on borrowers' assets, as well as monitoring and studying delinquent loans to identify cases that should receive extra attention. It is important to note that Florida is a recourse state that allows lenders to pursue deficiency judgment post-foreclosure.
Fannie's new measures were adopted to prevent the increasing number of losses that may result if borrowers continue to strategically default on loans they can afford because the value of their home has greatly depreciated. As of February, Morgan Stanley estimated 12% of defaults to be strategic. With almost 25 percent of homeowners with mortgages currently "underwater",continued strategic default would most certainly exacerbate Fannie and other lender’s mortgage loss.
Fannie Mae is acting on concerns held by most lenders that it is becoming common and acceptable among society for financially able borrowers to stop paying their loans. Executives of Fannie believe this growing practice of strategic default is "bad for borrowers and bad for communities." Such default strategy may be viewed as being in the best interest of the particular borrower, but if the use of strategic default continues and grows it could worsen the already depressing conditions of the housing market.
Although Fannie has sharpened its penalties, it is also preparing to counter the increased penalty period by reducing the lock out periods for borrowers experiencing legitimate hardships who cannot avoid foreclosure. The previous waiting period of five years was applied to all borrowers who went into foreclosure across the board, regardless of the borrower's circumstances. Under the new plan, borrowers experiencing legitimate hardships will receive a two year lock out period if they exercise the option of transferring their homes to the lender through a "deed in lieu of foreclosure" or completing a short sale. In the absence of a deed in lieu or short sale, if the borrower can provide documentation of extenuating circumstances and/or show that an effort was made to negotiate with the lender, the lock out period may be shortened to as little as three years.
Some believe that the increased lock out period will do little to curb the number of strategic defaults based on the little deterrence that resulted from Fannie's previous lock out period increase in 2008, however, Fannie Mae's new policy of pursuing deficiency judgment should be taken very seriously by borrowers who live in recourse states such as Florida.
For information on strategic default, deficiency judgments and other mortgage and debt issues, please visit www.yesnerboss.com