Trust me, Believe me, It's all in the art of stopping
Wire -- In the Art of Stopping
There is an art to strategic default. There are many options, and some have stronger consequences than others. Does the borrower want to maintain some lines of credit? Will selectively defaulting on certain debts hurt their credit score more than others? Will strategic defaulters need to declare bankruptcy?
Now that millions have defaulted on their mortgage, we have anecdotal data and research studies on what really happens to those who quit paying. The results will surprise some and inspire many.
One of the most cited deterrents of deciding whether or not to foreclose or strategically default is the fear of a catastrophic and irreversible hit to one’s credit score, leading to an inability to rent, purchase a new car or home, or open a new credit card. After polling some of our 5,000 clients nationwide, YouWalkAway.com has discovered it’s a fear that may be blown way out of proportion.
Susan Edwards is a client of YouWalkAway.com, a company that walks defaulting homeowners through the foreclosure process. Edwards recently walked away from a property in Southern California. “Prior to missing our first payment, my credit score was 805,” Edwards stated “I checked it again in June after we missed the 5th payment and it was 680. At the time, it was commonly reported that the average foreclosure would lower your credit score about 150 points. I had assumed it would stay in that range for up to 7 years. I was wrong.”
So, what is Edwards credit score now? According to Edwards, after only 3 months following the foreclosure auction of her property, her credit is back up to 734 and climbing. Fortunately, the hit taken to her credit was not nearly as bad as most people, including those who claim to be experts, might have depicted.
If this woman's credit score gets back above 740, there will be no real ramifications for her default. Most lenders don't have a super-duper category for those with FICO scores over 740, so the borrower with a 745 is getting the same rate and the same treatment as someone with an 805.
Edwards is not the only YouWalkAway.com client to see her credit rebound so quickly. New York resident and YouWalkAway.com client Jodi Romanello has walked away from two investment properties in Florida. While she has never closely monitored her credit score, Romanello has yet to see any negative repercussions of a credit drop. “When I first skipped payments on my first foreclosure, CitiBank Diners Club abruptly canceled my card due to ‘undesirable changes in my credit rating,’” Romanello explained. “I got very upset because I hadn’t thought this would happen, but to my enormous relief none of my other cards did this. I have a high limit with American Express Gold, Visa, MasterCard and a lot of store cards, and Amex just renewed my card with an invitation to go Platinum.” Romanello continued to explain how she staved off the negative credit effects of two foreclosures, “I am careful to pay all other bills instantly when I receive them, I run no balances on any cards month over month.”
The key to keeping a high credit score is to selectively default. Some people who strategically default stop paying on all their debts, often as a precursor to bankruptcy. Anyone hopelessly overloaded with debt is probably wise to follow that path. However, for those who can afford to maintain other credit lines, and feel the need to do so, can simply stop paying their mortgage and keep paying everything else.
Most borrowers are defaulting on their first mortgage and keeping other debts current which is helping their credit scores.
According to the study, credit cards, car payments and student loans are the most common forms of additional debt, with personal loans and medical loans rounding out the bottom. Surprisingly, only 23% of those surveyed have ever defaulted on any other debts. Many YouWalkAway.com clients have never even had a late payment on their record prior to strategically defaulting from a property. Although, 91% of underwater homeowners surveyed are facing other debts in addition to their mortgage, YouWalkAway.com has seen these recurring trends amongst many clients. Those who have handled the foreclosure strategically by closely monitoring their credit and other debt are fairing much better financially after the foreclosure.
Lenders should be thrilled that borrowers can't seem to kick the habit. People want signatory debt, and they would rather walk away from their underwater house than default on their other debts. Personally, I think people should get rid of all their debts and live on the positive side of the financial ledger, but that isn't what most borrowers are doing.
Even borrowers who opt for a short sale have seen quick restoration of their credit. San Diego Real Estate Broker, Jeff Grant can attest to his credit recovering after a short sale of his investment home which was upside down by more than $200K. “After my own short sale, missing a total of 8 mortgage payments, my credit went from 729 to 679. But it quickly recovered to 728 a year and four months later!”
Less than 18 months after a short sale, and his credit score is basically unchanged. Why would anyone fear the credit implications of a short sale?
Following in suite, Wynn Bloch’s house in Palm Springs, CA sold at foreclosure auction in March 2010. As a result of the foreclosure, her credit score fell just 45 points – from 780 to 735. “It didn’t hurt me really at all,” Bloch stated, “In fact, I was foreclosed upon last March and just bought a new house in December!” While it may be unlikely for all defaulting homeowners to purchase a home so quickly, 51% of YouWalkAway.com clients polled do wish to purchase a new home within 5 years.
From foreclosure to homeowner in less than a year. Perhaps lenders should be tougher on these people, but the need for warm bodies to sign a loan document is prompting lenders to forgive and forget.
In reality, many YouWalkAway.com clients are more than happy to shed the excess baggage of their underwater homes and downsize to a rental. Nearly, 100% of clients report saving money by renting, and 52% chose to rent a house smaller than their previous one. Jon Maddux, CEO of YouWalkAway.com explains, “Eighty-one percent of our clients have experienced no issues renting after a foreclosure or short sale. Only, 18% were asked to provide a slightly larger deposit.”
As Susan Edwards shares, “I love being at our new house. I can imagine my dogs in the yard and our family sitting at the table for Thanksgiving. Funny,” she continues, “but I’m more excited for [my new rental] than I was when we bought this house. It really is a new beginning for us.”
Renting is a huge relief to people escaping a huge mortgage payment. Home is where the heart is, it doesn't require a big loan.
Edwards, Romanello and Bloch are not exceptions to the rule or lucky strategic defaulters who have fallen through the credit reporting cracks. They are living proof that if homeowners continue to keep on top of other debts and their credit scores, they can rebound much faster than initially predicted.
Maddux continues, “There has been a lot of misinformation regarding the effects foreclosure has on one’s credit. More often than not, it is those who have an agenda to deter homeowners from walking away who use scare tactic phrases such as, ‘Foreclosure will destroy or decimate your credit.’
That is exactly why lenders try to foster the perception that default will be harmful. It's only harmful to those who want to use credit, and apparently it isn't very harmful to those who want to get another home loan.
Due to the nature of how credit scoring works, I prefer to describe the effects of foreclosure as wounding one’s credit. Blemishes will heal on their own as long as one continues to keep other lines of credit current. Seeing it first hand with our own YouWalkAway.com clients, a homeowner’s credit will improve over time as the delinquent payments move further into the past.” ...
Lenders want to keep the millions who would benefit from strategic default in a state of fear and confusion to compel the borrowers to keep paying. They would prefer to publicly endorse borrowers most macabre fantasies of strategic default while quietly soliciting new customers behind the scenes. Prior to the blog era, they might have been successful.
People who default on their mortgages — but no other debts — are not as risky as expected, according to a new study from credit monitor TransUnion.
TransUnion's research shows that those who only default on mortgages are less likely to then default later on new car loans or credit cards than are people who default on mortgages and at least one other debt at the same time.
The study results, to be released Tuesday, also show that mortgage-only defaulters saw credit scores rebound faster than people who defaulted on multiple loans, which could include people who went bankrupt.
The mortgage-only defaulters "are less risky than they appear," says Steve Chaouki, TransUnion vice president. "Lenders will want to lend to these people in the future."
There you have it. The already light punishments for strategic default will be lessened even more in the future, provided the strategic defaulter is calculated and selective in their default.
TransUnion, like other credit-management firms, is seeking insight into mortgage-only defaulters, who could prove to be a big market for lenders. In the past five years, almost 4 million U.S. homes have been lost to foreclosure, says market researcher RealtyTrac. A chunk of those were "strategic defaults," in which homeowners who could afford to pay their mortgages walked because home values had tanked so much.
FICO, keeper of the widely used FICO credit score, last month released one of the first credit studies on strategic defaulters and found them to be savvy about credit, with better credit histories than other mortgage defaulters.
As with FICO, TransUnion did its study — "Life After Foreclosure" — after enough people had defaulted and results could be considered valid.
TransUnion's research should diminish expectations that mortgage-only defaulters will join the ranks of habitual defaulters, Chaouki says.
Fear of being lumped in with the riff-raff is largely what prevents many with good credit for defaulting. Information like this will likely push many off the fence and into a new rental.
For instance, 5.8% of mortgage-only defaulters examined in the study were at least 60 days delinquent on new car loans which were opened after they defaulted on their mortgages. But 13.1% of the multiple defaulters were at least 60 days delinquent. The mortgage-only defaulters also had lower 60-day delinquency rates for credit cards, 11.4% vs. 27.1%. Both measures were taken at least 120 days after mortgage defaults.
Credit scores for mortgage-only defaulters bounced back quicker, TransUnion also found. For instance, consumers with Vantage credit scores — a competitor to FICO scores — in the 631 to 650 range saw their scores rise a median 8 points 12 to 17 months after defaulting on mortgages. People in the same credit score range with multiple defaults saw their credit score drop by 2 points. Vantage scores range from 501 to 990. ...
People considering strategic default who wish to maintain their credit use should default only on their primary mortgage. The punishments aren't that bad, and they are likely to be lessened as time goes on.
Although, there are some consequences....
What did they need $650,000 for?
The owner's of today's featured property were solid borrowers who paid down their mortgage through the entire housing bubble when all their neighbors were borrowing money and spending like drunken sailors. But then in the summer of 2007, they obtained a $650,000 stand-alone second from a private party.
The owners who show a pattern of HELOC abuse simply spent the money as if they had earned it, but these rare cases where borrowers have large private loans, something unusual happened. Based on what the property records show, they used this HELOC to leverage themselves into a much larger home.
Before the property crash, people used to sell their properties before moving up. Perhaps they wanted to keep this one as a rental, or perhaps they didn't want to sell it for less than its peak value. In either case, they now have a massive debt on this property to go along with the $1,104,614 debt they have on their new property. With over $800,000 in debt on this property, it isn't cashflow positive.
Basically, they leveraged their modest down payment on today's featured property into two properties with nearly $1.9M in debt between them. For their sakes, I hope they either make a great deal of money or Irvine real estate starts going up.
-$498 .......... Tax Savings (% of Interest and Property Tax) -$760 .......... Equity Hidden in Payment (Amortization) $248 .......... Lost Income to Down Payment (net of taxes) $111 .......... Maintenance and Replacement Reserves ============================================ $3,175 .......... Monthly Cost of Ownership
Cash Acquisition Demands ------------------------------------------------------------------------------ $7,290 .......... Furnishing and Move In @1% $7,290 .......... Closing Costs @1% $5,832 ............ Interest Points @1% of Loan $145,800 .......... Down Payment ============================================ $166,212 .......... Total Cash Costs $48,600 ............ Emergency Cash Reserves ============================================ $214,812 .......... Total Savings Needed Property Details for 65 ESSEX Irvine, CA 92620 ------------------------------------------------------------------------------ Beds: 4 Baths: 4 Sq. Ft.: 2500 $292/SF Property Type: Residential, Single Family Style: Two Level, Craftsman View: Trees/Woods Year Built: 1998 Community: Northwood County: Orange MLS#: S658156 Source: SoCalMLS Status: Active ------------------------------------------------------------------------------ * * * FANTASTIC LOCATION IN AWARD WINNING NORTHWOOD POINTE * * * 4 bedrooms plus an office in almost 2,500 square feet, 3.5 bathrooms, 2 car attached direct access garage, large and private yard, upgrades include wood floors, custom paint, newer carpet, custom built-ins, ceiling fans. Located less than 100 yards to award winning schools, meadowood Swimking Cnter, Citrusglen Tennis Center, Hicks canyon Hiking Trail and easy access to freeways, shopping and recreation.
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