Signs of Strategic Default
Investors trying to work short sales for distressed homeowners will do well to know up front that the homeowner is truly distressed before contacting the lender. Lenders look for signs that homeowners have the ability to pay and will reject short sale requests from those who do not meet criteria for hardship. A homeowner who is not distressed and defaults on a loan as a business decision is engaged in a strategic default. Requests for short sale or a loan modification on a strategic default are not very likely to be successful, at least not for residential property.
Signs of distress include:
–One or both homeowners have lost a job or have been cut back substantially in work hours.
–The owner’s small business failed.
–One or both homeowners are on a fixed retirement income and have lost significant value in retirement resources.
–A medical problem or other unavoidable expenses have increased debts.
–The homeowner has reached insolvency.
–The homeowner has found a job outside of the area and needs to sell.
–The family has had children and need more space triggering the need to sell the current house.
FICO has recently developed a software product for lenders to use in order to weed out those who are defaulting merely to be rid of an under water mortgage as a business decision from those who are truly in need. This software has the ability to identify those individuals who are over 100 times more likely to strategically default.
In addition to having an under water mortgage the strategic defaulter is likely to have a higher FICO score than a distressed homeowner. They tend to have lower balances left on revolving credit lines. They don’t use much retail credit, nor do they exceed their credit limits very much. The strategic defaulters may well have significant assets, much of which is protected in other entities.
These individuals are more likely to see defaulting on an underwater mortgage as a good business decision. They calculate the likely hit that will be taken on the credit score and determine that the negatives are less important than the long term financial benefit of getting out from under the negative mortgage.
It was estimated in 2010 that as much as 35% of all defaults were strategically motivated. The number is hard to pin down because most strategic defaulters try to cover the tracks with hardship reasons.
Whether you believe strategic default is a smart business move or an immoral strike at the economy, any real estate investor will run into cases where the hardship just doesn’t add up. If it doesn’t add up for you, it almost certainly won’t for the lender and it is not a good bet for a successful sale.