There’s been a lot of discussion on the subject of Strategic Default over the last year or so, with no shortage of passionate viewpoints. It’s a favorite topic in all forms of media. The last time we posted an article on this subject (Feb ’10) it created a virtual firestorm of response.
Ethical and legal arguments aside, it’s always been our opinion that the most practical solution to this issue is for lenders to reduce principal loan amounts. If you can make payments on a $350K loan but the home is only worth $200K, then does it make sense for your lender to reduce your principal to match the fair market value of your home? Yes, and here’s why:
- If you don’t have a “hardship,” you only have two options: take your lumps or walk away. You don’t qualify for a loan modification or a short sale.
- You likely chose your home for the lifestyle it offered, rather than as an investment. You would be content to stay if you didn’t feel like the value was a total loss.
- Lenders (and their investors) prefer performing loans to non-performing loans, and it’s well-documented how costly walk-away defaults are for lenders.
- Governments like performing loans, too, but their solutions aren’t working.
A principal reduction modification could even be an equity-share agreement. The borrower agrees to share any equity growth with the lender at the time of sale. It’s a no-lose proposition. Sound improbable? Well, it’s already happening.
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A close friend very recently received such an offer. It came in an overnight express package directly from the lender, a major bank, with a no-strings offer to reduce the principal loan balance by a substantial amount. After a lot of “must be a scam” follow-up, it turned out to be legit. Now the loan balance is lower than, or near market value. The borrower can consider new options: stay and make improvements, or even sell without a loss.
The property in question had lost over 35% value since purchase, and was worth considerably less than the loan balance. The payments were much higher than comparable rent. Numerous attempts at loan modification failed because there was no hardship. The borrower could still easily afford the payments, and loved the house, but was seriously considering walking away. Seemed like a sound business decision. Nonetheless, they continued to stick it out. After about a year, a new lender acquired the loan, and almost immediately they offered the principal reduction.
Some suggest that there is no such thing as “doing the right thing.” Compared to what? Nevertheless, my friend was rewarded for being faithful and credible. Everybody wins. No legal consequences, no ethical dilemma, lifestyle intact, the loan doesn’t default and the bank doesn’t have to dig the occupants out.
There are some prerequisites to qualify for this offer. I can’t verify this, but from what I understand you have to be current with your payments and it applies only for purchase money, not cash-out refi’s.
This is definitely more the exception than the rule, at least so far, but I expect we’ll see more of this. There is hope for those you who are hanging in there, and there is still some good old-fashioned common sense afoot in the land of “I, me-me, mine.”
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