Much has been written about strategic mortgage defaults lately. Bank of American (NYSE: BAC – News) is fielding more than 125,000 calls a day from people seeking mortgage help. Hundreds of thousands haven’t made a mortgage payment in more than a year.
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?