strategic defaults and your credit score

[Deleted]

I read somewhere that lenders are recognizing that people who strategically default are more likely to have high scores. I can't remember FICO being mentioned in the article.

"The majority of people who do strategic defaults on home mortgages have high credit scores. So if FICO were to take this into account, having a high fico score would mean at least a little bit more risk for the mortgage lender. Therefore, FICO should lower your score if you have a mortgage and a high score."

That almost makes sense in a weird kinda way. But I don't think that's what should happen. You can only go so far in predicting what people will do. People that have walked the straight and narrow for years shouldn't be punished because others like them went off in another direction.

[Deleted]

" You can only go so far in predicting what people will do. People that have walked the straight and narrow for years shouldn't be punished because others like them went off in another direction."

Agreed. A far better indicator for strategic default is whether the house is significantly underwater.

[8 Bit WWBG]

...:::"Agreed. A far better indicator for strategic default is whether the house is significantly underwater.":::...

That, and if they suddenly apply for a mortgage for a home that is in the same or close area to the underwater house they are currently paying on.

[raeoflyte]

May 23, 2011 10:57:36 GMT -5 8 Bit WWBG said:

...:::"
That, and if they suddenly apply for a mortgage for a home that is in the same or close area to the underwater house they are currently paying on.

They are and I believe will continue to really tighten up underwriting guidelines when people do this. It can be tough for the people legitimately moving and wanting to keep the underwater home as a rental.

[Deleted]

I thought the idea behind a strategic default is you could continue to pay your mortgage, but have a large financial benefit to not doing so. That being the case, I would expect most (there I go using "most") ;D of these people to have 700+ credit scores.

[Lex Luthor]

The majority of people who do strategic defaults on home mortgages have high credit scores.

Agreed. A far better indicator for strategic default is whether the house is significantly underwater.

Your YM strategic defaulter here. Yes, I had an excellent credit score. BUT....

The biggest factor in our decision to default was a combination of the fact that my house was near 50% underwater at the time of default AND we stood to save a significant amount of $$ by either renting or owning a home in our area. If we were 50% underwater, but couldn't save money or get any value out of defaulting - there would be no incentive to do it.

The high credit score may simply be an indicator of whether or not someone is actively managing their money/bills. And may indicate an awareness of financial matters - one of which is the active choice to stay in or leave a home that is significantly underwater.

There are really three conditions that I believe should be met prior to strategic default and while they have nothing to do with a credit score, you would need to be aware of several financial issues related to defaulting:

1. Your loans are non-recourse or you can declare bankruptcy to avoid a deficiency judgement
2. You will not be paying taxes on Debt Forgiveness Income due to the Mortgage Forgiveness Debt Relief Act (which expires at the end of 2012)
3a. You will make a substantial amount of money by either renting or owning an alternative residence OR 3b. Your alternative equivalent cost residence is giving you a substantial amount of intangible personal gain (significantly better school systems, drastically reduced commute, much safer area, etc)

I am interested to see what happens near the end of 2012 when the Mortgage Debt Forgiveness Act is set to expire. I don't think the Act will be extended due to the actions of people like myself. And I think bankers will take advantage of this and postpone short sales and foreclosures near the end of 2012 and push them into 2013, and then use the tax consequences as a negotiating tool.

So if FICO were to take this into account, having a high fico score would mean at least a little bit more risk for the mortgage lender.

Maybe. It's kind of one of those chicken or egg questions. My opinion is that it is the actions of the lenders who caused otherwise high credit score borrowers to act differently. Anyone who has been paying attention to the housing boom/crash should be quite aware that bankers/lenders essentially built a massive ponzi scheme in order to gain large short-term profits. When that ponzi scheme was no longer sustainable, the housing market crashed. If the bankers/lenders hadn't made such short-sited decisions, then borrowers who had great credit scores and thus presumably made good financial decisions from the beginning wouldn't feel like they needed to make bad "credit score" and "moral/ethical" decisions now, in order to make good financial decisions for their futures/families.

[AgeOfEnlightenmentSCP]

FICO is based on old assumptions of what people will and will not do. That is why it is increasingly irrelevant. It makes perfect sense to me that before you can have a low credit score, you need to have had a high one. How else do you borrow the money to not pay back?

[AgeOfEnlightenmentSCP]

May 23, 2011 10:57:36 GMT -5 8 Bit WWBG said:

...:::"Agreed. A far better indicator for strategic default is whether the house is significantly underwater.":::...

That, and if they suddenly apply for a mortgage for a home that is in the same or close area to the underwater house they are currently paying on.

Yep. The problem is that lenders don't typically take the first house into account except as part of an overall debt to income ratio. Lenders rarely take debt to equity into consideration except for the property that they are loaning money against.

[Lex Luthor]

Yep. The problem is that lenders don't typically take the first house into account except as part of an overall debt to income ratio. Lenders rarely take debt to equity into consideration except for the property that they are loaning money against.

Not exactly. When we did our buy and bail there were quite a few conditions we had to meet for the new lender to loan us funds for a "rental" residence.

First, our income HAD to be high enough to cover the mortgage payments on all properties and all debts. No rental income was taken into consideration when calculating the debt to income ratio.

Second, we HAD to put 25% down, nothing less.

Third, we HAD to buy a home that was smaller in both sq ft and number of beds/baths than our primary residence.

Failure to meet any of these conditions = no loan.

[Deleted]

May 23, 2011 11:00:14 GMT -5 raeoflyte said:

May 23, 2011 10:57:36 GMT -5 8 Bit WWBG said:

...:::"
That, and if they suddenly apply for a mortgage for a home that is in the same or close area to the underwater house they are currently paying on.

They are and I believe will continue to really tighten up underwriting guidelines when people do this. It can be tough for the people legitimately moving and wanting to keep the underwater home as a rental.

We are going through this right now.. New property closes in 35 days. New property is 20 miles from old property. Old property will become a rental. The documentation requirements were extreme in my view with many follow ups from the lender. Ultimately we got approved because our income supported both properties without rental income factored, we had 20% down on the new property, and the old property still has some equity.

[achelois]

All I can say is that I hope lenders develop stringent requirements and demand large downpayments in future before lending money for mortgages.

[Plain Old Petunia]

<< Ultimately we got approved because our income supported both properties without rental income factored, we had 20% down on the new property, and the old property still has some equity. >>

If the old property has some equity, then you aren't upside down.

<< Third, we HAD to buy a home that was smaller in both sq ft and number of beds/baths than our primary residence. >>

That's interesting. I wasn't told that. I hope they weren't waiting to spring that on me later.

My home value continues to sink, I am now at 146% LTV.

[Deleted]

"I am interested to see what happens near the end of 2012 when the Mortgage Debt Forgiveness Act is set to expire. I don't think the Act will be extended due to the actions of people like myself."

That's the thing. I think this was a bad act as it really protected higher wealth defaulters. If by the IRS' definition you are considered "insolvent" meaning liabilities exceeds assets you don't owe the tax.

www.irs.gov/newsroom/article/0,,id=201877,00.html

[Deleted]

May 23, 2011 13:47:52 GMT -5 Plain Old Petunia said:

<< Ultimately we got approved because our income supported both properties without rental income factored, we had 20% down on the new property, and the old property still has some equity. >>

If the old property has some equity, then you aren't upside down.

Key word was *some*.. If we were to sell it, after realtor fees, we would probably be a few bucks out of pocket. But my point was that even though we weren't upside down, we still had to jump through 1000 hoops in part because of strategic default people.

[Plain Old Petunia]

<< Key word was *some*.. If we were to sell it, after realtor fees, we would probably be a few bucks out of pocket. But my point was that even though we weren't upside down, we still had to jump through 1000 hoops in part because of strategic default people. >>

Sure, once there are new hoops everyone has to jump through them. You're not much of a risk, though, as you won't come out ahead by doing a strategic default. Someone like me on the other hand, I'm a risk. I can completely understand why I should have to show I can swing both mortgages while collecting no rent. Even so, there is a high risk I might choose to default.

[Plain Old Petunia]

<< That's the thing. I think this was a bad act as it really protected higher wealth defaulters. If by the IRS' definition you are considered "insolvent" meaning liabilities exceeds assets you don't owe the tax. >>

I just read through this. Retirement assets count when determining insolvency. So for someone like me, in order to escape tax, the foreclosure needs to happen by the end of 2012.

[Deleted]

Petunia,

Did you talk to a CPA yet? I'm still of the opinion that a non-recourse loan foreclosure doesn't result in any kind of loan forgiveness e.g. If the purchase money loan was for $200k and the bank can only get $100k at auction there is no $100k to forgive.

But it's a whole 'nother story if you pulled out equity or refied.

[Plain Old Petunia]

Hi Bonnap,

I have talked with my boss (CPA) about it. My hold up is I am not certain I will come out much ahead as I would have to pull part of my down payment from an IRA.

I have done a refi, but I owe less now than before the refi, so I don't have a problem there.

I'm still on the fence. If home prices plunge again as some are saying, that would tip me.

[Deleted]

"I have done a refi, but I owe less now than before the refi, so I don't have a problem there."

Better double check that with an attorney who specializes in foreclosure. Before I left the States, any kind of refi changed the loan from a "purchase money" to a recourse loan in CA. (Interestingly enough AZ allows for a non-cash out refi).

Now I know there was some kind of legislation recently passed about deficiency judgments in CA but I don't know the details.