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Frugal Homeowner®



New Rules Punish "Strategic Foreclosures"

QUESTION:  What in the world is a “strategic foreclosure”?  Is that when people owe more than the house is worth and just walk away?  If that’s the case, why don’t more people do it?----LK

ANSWER:  A “strategic foreclosure” is a term that’s sprouted up as a result of the mortgage meltdown.  It’s a conscious decision made by a property owner who owes more than the property is worth.  The strategy is to walk away from the property since holding onto it and making payments will cost more with little hope of building equity in the near future.

While strategic foreclosure may seem like an easy out, there’s much more to the story.  Foreclosure can severely damage an owner’s entire credit picture---everything from the rates you pay on auto insurance to whether or not you’re chosen for a job.  And in Fannie Mae’s latest move last week, walking away from a mortgage can prevent you from obtaining another Fannie Mae mortgage for seven years.  In the states where deficiency judgments are allowed, Fannie Mae will even take legal action to recoup the outstanding mortgage debt remaining on the loan.  While record numbers of defaults are piling up the red ink, Fannie Mae cited this new guideline to reinforce the importance of working with your mortgage servicer in lieu of walking away from the mortgage.

This latest Fannie Mae guideline ignited a firestorm of comments since many strategic foreclosures involve high-end properties with mortgages often in excess of $500,000 or more by owners who can actually still afford to make payments. Some comments praised owners for having the insight to do the math and see that they stood to lose more by continuing to make payments on a financially underwater property.  Others claimed that this new rule was an idle threat since borrowers’ can obtain an FHA mortgage just three years after foreclosure with less down payment and a lower credit score than with conventional mortgages.  Still other exasperated homeowners’ commented that since Fannie Mae is approximately 79% governmentally owned, the semi-government CEO’s should be asked to return their hefty bonuses as well. And then there were those who blamed the owners themselves for foolishly over-leveraging to purchase cars, RVs, and other personal property using their home equity as a piggy bank.

One very real concern in penalizing financially qualified buyers with the no-mortgage-for-seven-years rule is that it will cause inventory to continue to stack up and further slow the housing market recovery.  That said, the majority of Americans conscientiously choose to continue to stay in their home, make their payments, and hope that equity will eventually return.

Fannie Mae and sister company, Freddie Mac currently back approximately 95% of all conventional mortgages.  While Freddie Mac has not announced its plans to clamp down on strategic defaults, it’s likely that stricter guidelines from the pair will continue to impact existing homeowners and new borrowers in the future.


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