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Should you short sale your home? Strategic Defaults 101

What are “strategic defaults” and why are more and more people considering this option?

A strategic default occurs when a homeowner who can afford to make their monthly payment chooses to stop paying and short sale their home because they feel it is a bad investment. With over 5 million homes now “upside down” it is clear to see why so many feel their investment has gone bad. While the decision to walk away from a home you could technically afford may seem to go completely against the norm of society, it is interesting to note that corporations, investors and even banks (!) have been doing it for years.

Recently several reports have been written discussing the topic of “strategic defaults” and short sales. The majority have overwhelmingly concluded that if homeowners could look at their property from a purely financial perspective then strategic defaults would certainly appear to be a reasonable decision. Brent T. White, a University of Arizona law school professor asserted in his paper titled “Underwater and Not Walking Away: Shame, Fear, and The Social Management of the Housing Crisis” that “Homeowners should be walking away in droves, the financial costs of foreclosure, while not insignificant, are minimal compared to the financial benefit of strategic default.”  He also states that until homeowners are able to look at their property as a failing investment and simply walk away, the banking system will not be forced to re-examine their willingness to actually modify mortgages.

According to White the reason some people continue to pay on a mortgage despite the home’s loss of value is a result of “misplaced loyalties and antiquated values (that) prevent otherwise clear-headed individuals from simply walking away from a bad business deal.”

However, with the general consensus that banks have used predatory lending practices and have actually benefited from this crisis and the question of values or ethics gets tossed out the window. Liz Puliam Weston of MSN has stated “Lenders showed an astonishing lack of morality and responsibility by pushing risky loans. They could have redeemed themselves by getting serious about restructuring mortgages to make them affordable, but their efforts so far have been pathetic. Regulators, meanwhile, stood idly by while the foxes raided the henhouse, and lawmakers dropped the ball by not giving bankruptcy judges the power to modify home loans.”

But even taking the moral implications (if one considers there are any) out of the equation, there are still real consequences to letting a home go into foreclosure or choosing to short sale a property. And the cost of owning it should be compared carefully to cost of strategically defaulting.

It is important to note that a strategic default is still a default and has the same effect on credit scores. But unlike a traditional default, careful planning and a well structured short sale can help minimize the implications.

In the end homeowners paying on a mortgages that are worth half their value will decide what is in their best interest both financially and morally.

In the meantime we would love to hear what you think. Do you think that offering a home as a short sale carries a moral weight? Do you think that financial prudence and morality are linked?

Click here to read in full Brent White’s report or Liz Piliam Weston’s article.

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