Oct 18, 2010

The Loan Modification Process Can Help Avoid a Charge of Strategic Default

Banks are beginning to punish homeowners who engage in "strategic default," and pushing for legislation to do the same. A strategic default is defined as not paying your mortgage when you can afford to do so, thereby letting your home fall into foreclosure. (For a more comprehensive discussion of strategic defaults and the steps banks and legislatures are taking to punish homeowners, see my previous blog post The Government and Banks May Punish Strategic Defaults.) 


An Ounce of Prevention:  The Loan Modification Process

One way that homeowners can reduce the risk of a strategic default accusation is to use the loan modification process.  (To learn about loan modifications, see Nolo's article Mortgage Modification and Refinancing Under the Homeowner Affordability and Stability Plan.)  Here's how it might help:

Because nonpayment when you have the ability to do so is the key aspect of a strategic default, your best protection against having this label applied to you is to make a diligent effort to obtain a loan modification. Of course if you don't really need a modification, the mere attempt to obtain one probably won't immunize you from being considered a strategic defaulter. But few people are that well off.

If your first mortgage is 31% (or more) of your gross income, you have a non-affordable mortgage under the Making Home Affordable guidelines, and failing to pay it should not be considered a strategic default on your part. And you may have additional reasons why you cannot afford your mortgage at the time you defaulted (for example, student loan repayment obligations, a second or third mortgage, or erratic periods of employment).

Defaulting After a Obtaining a Loan Modification Might Hurt You

On the other hand, If you do obtain a modification and then immediately default without a change in circumstance, you may be considered a strategic defaulter almost by definition. (However, obtaining a loan modification is no easy feat.  See my previous blog post More Money for Foreclosure Prevention: Will It Help?)

So, if your main goal in participating in a modification process is to avoid this label, success may be failure, and failure success. Such are the strange times we live in.

Document Everything

If you think that you might be considered a strategic defaulter, be sure to thoroughly document your modification efforts. Use email or the post to document all discussions with the bank or a HUD-approved housing counselor. If you receive a phone call from the bank or counselor, follow up with a confirmation letter and record the names and titles of everyone you talk with. Your goal is to be able to provide a ton of paperwork showing that you diligently sought a modification and your default was not made for "strategic" purposes.