Foreclosing as a Financial Strategy

More than ever, there are mixed messages out there for homeowners thinking about walking away from their mortgage obligations.

The Federal National Mortgage Association, better known as Fannie Mae, recently announced that it would penalize borrowers who purposely forego their home loan payments and go into default–even when they can afford them–because the value of their home has fallen below the amount they owe the bank. Fannie Mae, in an effort to discourage these so-called “strategic defaults,” said it would prevent borrowers who walked away from obtaining “a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure.” Of course, the rules only apply to homeowners who have the capacity to pay and choose not to.

At the same time in California, state lawmakers are debating proposed legislation that would protect homeowners who strategically default from debt collectors. The California state Senate passed a bill earlier this month that would prevent lenders from seeking recourse for the amount of the borrower’s original home loan. If the borrower subsequently refinanced and took cash out of their equity in the home, however, the homeowner would be liable for what they borrowed above the original loan amount. The legislation is still pending and has yet to be reviewed by California’s State Assembly.

Though media reports have noted the rise of strategic defaults as the U.S. housing market attempts a recovery, the exact number of purposeful foreclosures are hard to come by. One Morgan Stanley analysis released in February estimated that these defaults accounted for about 12% of all foreclosures in the U.S.

Critics argue that California’s proposed law creates an incentive for homeowners to walk away. Here at Black Enterprise, we’ve advised that it’s almost never a good idea to engage in a strategic default. (See “Don’t Walk Away,” April 2010 issue) The repercussions are too steep.

John Simons is an editorial director and personal finance editor at Black Enterprise.