Strategic Foreclosures

Recently a story was aired on the news about the housing market in Patterson, CA and the dramatic decrease in median home values due to a high rate of strategic foreclosures. Also known as buy and bail, strategic foreclosures is the act of borrowers who have negative home equity in their homes – typically in the hundreds of thousands – qualifying for a loan on a second home, purchasing the second home and then defaulting on the first home mortgage.

Given the current housing market borrowers are able to purchase an equally sized home, sometimes larger and often within close vicinity of their current location for hundreds of thousand dollars less than what they paid for their current home. At a high level this makes financial sense. Why pay more for a home which you can buy down the street for half the price?

The downside to this process is that the people who “buy and bail” face seven years of bad credit with the inability to purchase a home for five years. However, in many cases borrowers face foreclosure on their first home anyway so they have little to lose. What I don’t understand is how people who face foreclosure on their first home qualify for a mortgage on a second home.

Apparently the process is perfectly legal although there are some ethical issues behind it. Some say it is fraud to buy and bail. However, I think home owners who face foreclosure have a different opinion. Many have begged and pleaded with lenders for loan modifications to avoid foreclosure with no results. Basically they are met with the response that unless you are in a “hardship” situation there is nothing they can do to assist you. What’s the definition of a “hardship” situation? Basically it means you have missed payments on your existing loan.

How are borrowers supposed to interpret this response? It seems clear to most borrowers in this situation that lenders are implying missing payments to receive help. Nobody wants bad credit and most borrowers have made legitimate efforts to work with lenders to work out an agreement which allows them to keep their home and repay their mortgage obligations with no avail. Lenders are simply not willing to help unless they are seeing a loss through missed payments.

In general, I think lenders are gambling that most borrowers who contact them about loan modifications are not willing to voluntarily take the plunge into foreclosure. However, the increased activity of buy and bail is evidence that borrowers are less concerned about their credit rating and more concerned about crawling out from underneath a mound of negative equity and high mortgage payments.

As a result, lenders are taking note and responding with stricter lending guidelines which require borrowers to show sufficient income to make payments on both properties without considering any rental income from the first property in the approval process.

So, what’s your opinion? Is buy and bail fraud or is it just the public response to a housing market that banks and lenders created in the first place?

  • Carol

    Frank,

    They are buying the second home before missing a payment and defaulting on the mortgage of the first home. They probably had good enough credit to be able to get a second mortgage. This is not a viable strategy for those who have missed payments, lost a job, have less income etc…

    People also do this when they need to move to a new state because of a new job etc… They buy a second home in another state and then let the home in the old house default.

    • Carol,

      Thanks for the response. You’re right. The buy and bail “strategy” is not viable for those who have missed payments on their existing loans. In that situation they probably would not be able to qualify for a loan on a second home.

      The message I was trying to convey was that for those who have not missed payments, and seemingly can afford the mortgage payments lenders are not willing to negotiate loan modifications. So what options do people in this category have?

      The housing market crash has affected everyone and there are many people with legitimate reasons for needing to sell their homes such as in your example of relocating for a job but can’t due to the large amount of negative equity.

      If these people have good enough credit to qualify for a loan on a second home I don’t see a reason why they wouldn’t take advantage of that opportunity. I am not condoning buy and bail but it seems the lack of support from lenders themselves is promoting this behavior.