Strategic defaulters are homeowners who can pay their mortgage but decide to default on the loan—most likely because they owe more than their house is worth. As reported on June 24, 2010, in latimes.com, by E. Scott Reckard, Fannie Mae plans to take these strategic defaulters to court, and to limit their access to home loans for seven years. This amounts to nothing more than scare tactics because taking them to court is very difficult and costly, and their access to new loans is already limited by the bad credit resulting from the home loan default.
A mortgage may be foreclosed through judicial foreclosure or power-of-sale foreclosure. Power-of-sale foreclosure is relatively easy. Every mortgage has a deed of trust. A trustee will be appointed, upon default, which has the power to sell the house, and pay the proceeds to the lender, quickly and efficiently, without involving the court system.
A judicial foreclosure, by comparison, involves the court system, is very time consuming, and expensive. It is the only way to obtain a deficiency judgment—a judgment against the defaulting homeowner, that makes up for the difference in value between the mortgage and the value that the house brings at the foreclosure sale. Even in the case of a judicial foreclosure, a deficiency judgment in California can be obtained only on refinanced homes, not on mortgages that were used to purchase the home (purchase money).
Fannie would have to identify such a strategic defaulter, make sure that their mortgage is a refinance, and take them to court at great expense in time and money, all in the hope of obtaining a deficiency judgment that can be enforced. Although strategic defaulters are those borrowers that can make payments on their mortgage, paying a large deficiency judgment will prove much more difficult than paying a mortgage. Fannie might find itself with a portfolio of judgments against judgment-proof defendants, all the while amassing the costs it incurred to obtain them. Not a winning strategy, even for a government-owned entity.
As far as limiting the defaulters’ access to new loans, this will happen anyway because the default will affect their credit score. Much like bankruptcy, walking away from your mortgage is a significant event on one’s credit report. It will take years to repair the damage and make the defaulter credit-worthy—most likely the same number of years that Fannie plans to “blacklist” the debtor. As long as Congress does not enact a lifetime ban on FHA loans to strategic defaulters, their access to new credit will happen roughly in the same time frame, with or without Fannie’s actions.
Fannie’s attempt to hang a Damocles’ sword over the head of strategic defaulters is a non-issue: in the case of ruined credit score, the sword was already there without Fannie’s doing; in the case of deficiency judgment, the sword is double-edged and it may hurt Fannie more than it hurts the debtors.
