As lending rules change, it gets easier (or harder) with each new year to borrow money for a home loan. In some years it can be done with little due diligence on the part of the lender.
In this case, some people purchase homes that they should not have been allowed to buy and with zero money down. When the payments come due, the result is that these families who trusted their broker would not lend them money they couldn't reasonably pay back can't make the payments.
After settling into a home in a nice neighborhood and good school district, many are left with a tough decision: they can either work harder and make more money (if possible) and suffer to make the payments that will never go down; they can spend every dime they have and possibly more until they are foreclosed upon because they won't be able to make payments like this forever; or they can save every dime they have and walk away from a deal that was made against their best interests.
The last decision is called strategic default.
How Strategic Default Works
In order to strategically default, a person needs to stop paying their home mortgage. After they miss a payment, their lender will be calling often. The home owner will not care for so much calling, but understands because they are now reneging on a deal they had made.
The person defaulting is not likely to tell the bank they are never going to pay because the ideal situation is to stay in the home rent-free for as long as possible, getting in arrears to the lender for possibly six months or more before being evicted.
During this time, the person should be saving money because they are going to need cash to get into an apartment or rental property after moving out.
Results of Strategic Default
After defaulting on a loan, your credit is going to be shot. One result is that you will need a double deposit for your next landlord. You should also not look into buying a car with a loan either because no one is going to want to lend to you in the next year or two.
You can look forward to seven years of bad credit following the finalization of your foreclosure or short sale, and this is not a bad thing. After all, you obviously were not prepared to purchase a home, so this time can be used to take the lessons learned and move on.
In moving on from this intentional act where you have walked away from a promise you made, you may find that there are other important aspects to this process.
Moral and Ethical Issues of Strategic Default
When you walk away from a home loan, you have to weigh the moral and ethical implications from both sides of the equation.
On your side, you made a promise that you could not (or would not) keep. You then strategized in a way to maximize your benefit while maximizing the lender's cost. And, in the end, you may have come out the better for it in the cash, or junk you bought with the cash, from not having had a house payment.
On the side of the bank, you were brought into a deal that you could not reasonably fulfill your end of the bargain on. Lenders will typically tell people that they can borrow an amount of money based on their gross (before taxes) income rather than their net. Buyers who listen to these experts end up having a great home that they can live in so long as they never go out on dates, get flat tires, or have to go out of town for a wedding or funeral.
In addition to this, the US taxpayers bailed out the very banks who are now still lending to people in this manner; the same banks who are in business because of bailouts while refusing to lower interest rates on credit cards that can get as high as 24.9%.
For More Detailed Information, Read: University Study on Strategic Default
It is important to understand what you are getting into when you default strategically. The window of opportunity to do so may be short or long, and the process can be heartbreaking, placing stress on you and your loved ones while you make a decision that will, ultimately, effect you for years to come. Once you have gotten through the idea, you'll have to face your feelings on the moral implications of the matter. From there, you will make the best decision for you and your family.
Join the Conversation