Who Walks Away From a Mortgage? Not Whom You'd Expect

walk away mortgagePeter Safronoff drives a Hyundai and lives in a rental bungalow in Encinitas, Calif., a beach community north of San Diego. At 63, it's not the golden-years lifestyle the financial consultant planned on, but it's the one he has.

"I live in a beautiful place, in more modest circumstances," he says, "but at least I know I won't go bankrupt now."

That's because last November, Safronoff walked away from his 1,600-square-foot home near San Diego, which he bought for $400,000 in 2005 with a 10% down payment. Like so many American homeowners, he lost his job in the financial crisis and watched the value of his house plunge. Unable to modify his loan -- and unwilling to push himself into complete financial ruin to keep his condo -- he made a strategic decision to pack his bags and leave the keys for the bank.

Homeowners like Safronoff keep the lending industry awake at night.

A report released in April by FICO, a credit-scoring and analytics company, offered tools to mortgage lenders to spot potential defaulters. They weren't who you might think: FICO's red flags included people with high credit ratings who were up to date on credit card and auto payments. As a financially savvy businessman with a credit score above 800 until very recently, Safronoff fits the profile.

His story follows a familiar trajectory. He bought his home in a boom market. When the economy turned, he lost his six-figure income, the value of his home plunged and his homeowner fees doubled. Relying on his $1,500 social security income and savings, Safronoff (pictured) found himself struggling to keep up with his monthly payments, which had ballooned to more than $3,700. Still, he never missed a payment. As he dug further into his savings, he was unable to qualify for refinancing, and his attempts to get a loan modification failed. Hundreds of faxes and many loan servicers later, he was at the end of his rope.

Safronoff says that while his attempts to find a solution met a dead end, he doesn't besmirch his lender, a national company. Still frustrated, however, he looked for other options and found YouWalkAway.com, an agency specializing in foreclosure planning or strategic defaults.

He is not alone. A study from the University of Chicago's Booth School of Business reported that 35% of mortgage defaults in September 2010 were strategic, compared with 26% in March 2009.

Jon Maddux, CEO of YouWalkAway.com, says his business mirrors that growth. Business is up 10% this year -- and had 40% annual growth in 2010 -- as more and more homeowners view walking away as a financially prudent decision.

Maddux says that his first wave of customers, in 2008, were much different than the ones he sees today. "In 2008 people were very saddened and in distress. They felt they had to save the house at all costs," he says. "But now people who were holding on really can't hold on any longer. We're seeing people who called three years ago call back."

Home Prices Expected to Keep Falling

The news for homeowners continues to get worse. A Zillow study this week reported that home prices have experienced the biggest quarterly drop since 2008 and may not hit bottom until 2012. Today, prices are down nearly 30% from the peak in 2006, and the number of negative-equity, or underwater, homes has hit a new high. Two million homes are in foreclosure, Zillow reported, with another 1.5 million seriously delinquent.

Ellen Harnick, a senior policy counsel at the Center for Responsible Lending, suggests that part of the reason that strategic defaults are occurring is that continued unemployment and the lengthy process for loan modification are leaving more people with fewer options.

"Studies have shown that negative equity is necessary but insufficient. People who walk away have had some other event, so that it's not a choice but a lack of options," she says. "For primary residents, you have to live somewhere. Most people will continue to pay mortgages as long as they can."

Some help could come for homeowners in proposed legislation for the Housing Opportunity and Mortgage Equity Act, which would allow any homeowner with a loan backed by Fannie Mae or Freddie Mac to refinance at the current rate, regardless of home value, income or credit rating.

What Is the Real Cost of Walking Away?

Public debate has centered on two issues: the ethical or moral question of walking away from a contract and the systemic risk to the housing market. Vocal critics of strategic defaults, such as economist Luigi Zingales at the University of Chicago, argue that walking away hurts market efficiency, increases mortgage prices, damages the community, and depresses the overall housing market. Add to that the damage of a broken promise.

But others, including University of Arizona law professor Brent White, say the question of whether to default strategically comes down to contract law. In White's view, the lender-lendee contract "explicitly sets out the consequences of breach." He argues that the agreement allows for a walk-away, provided the goods in question are returned. In other words, sending the keys back to the bank is part of the contract.

The possibility of walking away is a flashpoint for homeowners and lenders alike. Until recently, the only time planned foreclosures occurred were after major life-altering events: divorce, medical emergency, or business failure. In the last two years, the term "strategic default" has gained traction to describe walking away from a loan--also "jingle mail," from the sound of metal house keys clanking in an envelope.

For underwater homeowners, strategic default is one way to preserve remaining wealth, says Augustine Diji, a former real estate broker and founder of the website The Strategic Default Monitor.

Safronoff says that his decision to walk away was painful financially and emotionally. But it came down to economics and the relief he stood to gain as opposed to "sit in the house and freak out." He didn't see the process as ethically questionable because he says that he had tried all other options and saw this as a business decision.

The major penalty for strategically defaulting is the substantial hit of 150 or more points to a credit score. That means higher interest rates, more restrictive terms on credit and other difficulties obtaining financing. It could be hard to qualify for rental properties as well. In some states, lenders who sell a foreclosed property for less than the amount owed on the mortgage can pursue the defaulter for the difference, according to the FICO report.

The trend toward defaults underscores that credit may not be the king it once was.

"People's perceptions of credit are changing as we speak," Diji says. "There was a time when credit meant so much, and your score gave you so many benefits. Today, defaults throw that upside down."

Nicholas Carroll, blogger and author of "Walk Away From Your Debt," says the dot-com crash in the Silicon Valley in 2000-2001 foreshadowed the current wave of strategic defaulters. Looking back, he says, "people who walked away were back on their feet much sooner than people who tried to hang on." He adds that cash -- rather than a home -- is increasingly the new nest egg.

With peace of mind today, Safronoff is focused on rebuilding his financial life and reconstructing his credit. He doesn't regret walking away from his house but does not endorse it for other homeowners either.

"It was the right decision for me," he says, "but for others it may not be right. There is no simple answer."

Catherine New is a reporter with the Huffington Post Media Group.

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another article paint home owners who are smart enough to see the fraud in poor light

Who Walks Away From a Mortgage? Not Who You'd Expect

So what smart investors would just let fraud happen against there ivestment?


May 19 2011 at 5:09 PM Report abuse rate up rate down Reply

Be careful. In some states, letting a house go to foreclosure doesn't discharge the debt. The foreclosure in New York gives the bank a judgment for the outstanding balance of the mortgage, minus what they get dumping the house. There are about ten other states where this is true. You need a lawyer for a strategic default, because you might have to do a bankruptcy to fully discharge the mortgage.

May 19 2011 at 8:50 AM Report abuse rate up rate down Reply
Latoya Rutledge

Creative home sellers who offer seller financing to potential buyers can often sell their houses more quickly (and at a higher price) in a slow market.

While applying seller financing techniques isn't more difficult than traditional real estate sales, it is important to recognize that the buyers looking for seller financing represent a different target market than typical bank-financed customers.

Similarly, the process for obtaining a large cash payment for the seller after a note is created varies from the conventional real estate closing technique as well.

Fulfilling a Seller's Need for Cash

In some seller-financed real estate situations, the property owner may have an immediate need for more cash than is available from the scheduled principal and interest payments. This situation often comes about when the seller needs to have enough money to use as a down payment for their next real estate purchase.

In order to quickly obtain a large proportion of the money due from the loan they just created, the seller could sell the monthly note payments to a buyer for a lump sum of cash. By locating someone willing to buy the note payments, the seller will have ready cash for a down payment or any other pressing financial need.

In order to streamline the seller finance sale situation, it is advisable to have potential buyers for the newly-created cash flow at the ready. A seller can start looking for buyers before the note is created, or even before a seller-financed buyer is "lined up". This way, the property seller could have a buyer for the payment stream ready to make the purchase as soon as the new private mortgage is created.

Locating the Right Note Buyer

May 12 2011 at 1:46 AM Report abuse rate up rate down Reply

You can't walk away in certain states without banks or third-party lenders suing you like in Florida. In this state they can come after you with a deficiency judgment. Even if the bank does write off the loan, they can sell it to a third-party broker who will sue you. You'd have to declare bankruptcy in order to get the banks off your back. What may work in California doesn't work in other states. I'd be very careful about walking away. You may get served with papers and have to go to court.

May 11 2011 at 9:52 PM Report abuse rate up rate down Reply

great article

May 11 2011 at 5:22 PM Report abuse rate up rate down Reply