Q: My question is regarding a strategic default on a rental property. As with almost all homes, my townhome is underwater by approximately $100,000. I live in Maryland and my wife and I purchased this home in 2007.
We just recently purchased a new single family home and rented the townhome. We pay about $2,000 on the mortgage each month and receive rent of about $1750, so we are out of pocket $250 each month.
We are considering a strategic default, since our lender had declined us on a short sale, loan modification or refinance. Our tenants pay late, well after the first of every month. We wanted to know if we should let the tenants know about the strategic default. Should we stop collecting rent? What obligations do we owe to the tenant?
Just to be clear, we don’t want the property to be foreclosed on. We only want our lender to give us some relief on our loan. We would like to get the loan adjusted to the market value in our area, which should reduce the monthly payment. What should we do?
A: We are unsure whether you are truly considering a strategic default or merely want to threaten your lender with that action to “force” them to help you. Now that you have purchased another home, your options are more limited on what can be done with your townhome that is now a rental property. For example, many lenders will only refinance a primary residence. Rental properties, vacation homes, and second homes will not qualify for a refinance at today’s historic low interest rates.
While getting lenders to come to the aid of underwater homeowners is not an easy task, there are lenders who have granted some form of aid to their borrowers. Again, most of these programs aim to help borrowers that use their homes as their primary residence.
The part we find confusing is that you seem to feel entitled to obtaining relief from your lender even though you no longer live in the home and appear able to pay your monthly expenses on that home. Why should you be given any sort of help? Why should the lender be obligated to help you out of a situation you put yourself into?
An interesting element to your question is that you are only $250 short each month. You might want to talk to your accountant to determine how renting your townhome affects your federal income taxes. If you have no other business dealings and receive no income from other sources, you may not be able to benefit from the yearly losses from your ownership of the home until you sell the property.
But if you do have other sources of income and those sources can be used against the losses from the home, owning your townhome and taking a loss might actually help you out on your income tax return.
Now let’s talk about your tenant. If you stop making your mortgage payment, your lender will ultimately foreclose and your credit will take a huge hit. The tenant may be able to stay in the townhome for awhile and may be able to buy it from the bank. More likely than not, the tenant will eventually be out of a home when the bank takes over the property and sells it to someone else.
Only you can judge whether a strategic default is right for you. However, you should ascertain whether your lender has the right to go after you for the deficiency when they foreclose on the property. That is to say, your choice of strategic default may be in error, if you have the assets to pay the lender and the lender decides to go after you for the loss they sustain because of your default.
In some states, lenders may not have the right to go after a borrower when the lender takes over a home and the proceeds from the sale of the home aren’t sufficient to pay off the debt owed the lender – the deficiency. In other states, lenders have that ability, and if they do, you might find yourself hounded by credit collectors or sued by the lender to get whatever they can from you.
As you consider these issues, you can determine whether you want to move forward with a strategic default or keep the property rented and lose several thousand dollars per year. Please consult with a real estate attorney for more details.