Boomers, do the math before ‘strategically defaulting’

The Bakersfield Californian
June 9, 2011

They are called “strategic defaulters.” As home values continue to fall and the economy continues to struggle, their numbers are climbing, including among baby boomers, who are nearing retirement or who already have retired.

Boomers “strategically” defaulting on their mortgages — sending the keys to their homes back to their lenders — is not a phenomenon that is happening someplace else. It is happening in increasing numbers right here in Bakersfield.

This month, the media has reported distressing news: The nationwide housing market is experiencing a “double dip” — the plunge in home values that hit a plateau earlier this year has slipped over the edge. A new bottom likely will not be found until sometime next year.

Local real estate expert Gary Crabtree countered in a recent Californian column that Bakersfield’s market has not hit the dreaded double dip. And while local home values are dramatically lower than during their mid-2000 peak, a few homes are selling and some values are edging up.

There seems to be little disagreement, however, that the foreclosure rate is outrageously high, even in Bakersfield, and the stigma once attached to “foreclosure” seems to be disappearing. An increasing number of homeowners are “strategically” walking away from their mortgage debt.

Consider two recent clients who sought my advice about strategically defaulting. I have changed their names to maintain their confidentiality.

Patty is a boomer nearing retirement. She and her husband recently ended their years-long marriage with a divorce. She was left with their Bakersfield house, which was purchased when real estate was booming. The couple thought the house would be a good investment. They expected the value to go up.

Well, guess what. Both Patty’s marriage and the home’s value busted about the same time. The mortgage now exceeds the home’s value by more than $100,000. While she can afford the payments, she fears the value will continue to drop. With her post-divorce income sliced in half, she is scrimping on “necessities” just to make the monthly mortgage payments.

Her question to me: Should she take a walk, stop making payments and “strategically” allow her home to fall into foreclosure?

Another boomer couple, Brian and Sally, have been working with me to develop their retirement plan. Recently they brought Brian’s elderly father, George, to my office.

George, 86, is retired from a long career as a supervisor with a local oil company. He has a small pension and receives Social Security. He and his wife, Midge, were lifelong savers, putting their four kids through college, while living in a modest, 1950s vintage home in northeast Bakersfield.

When real estate boomed a few years ago, George and Midge sold their paid-for house and bought a smaller house in a retirement community. They used the proceeds to make a down payment on the house, landscape the yard around it, buy some new furniture, and pay off what they owed on a car loan and credit cards. They were not worried about the $200,000 mortgage. Home values were climbing. They believed when they needed to sell in future years, they would make a profit.

Shortly after moving to the retirement community, Midge was diagnosed with cancer. She died a few months later. George had a stroke two years after losing Midge. His children now believe George should not live alone. They are encouraging him to move into an assisted living complex.

And guess what. George’s retirement house now is worth about $125,000; that is, if he could find a buyer. He owes more than it’s worth. He needs to move, but he is stuck.

Brian and Sally asked: Should George walk away?

The answer to all who ask that tough question is: It depends. Everyone’s situation is different. Be cautious. Consult an attorney, accountant and financial planner. Do the math.

Some things to consider in analyzing the situation:

  • Do you still have equity in the property?
  • Can you afford to make the mortgage payments?
  • Do you have time to wait for an “economic recovery?” Are you young enough to wait out the housing slump? It may take 10 years to regain value.
  • If you default on the loan, will you be haunted by the terms of your mortgage or laws of your state? Can the lender seize your other assets to recover the amount you owe on the house? California provides protections for borrowers. Many states do not.
  • Will you need a good credit score within the next five to seven years? Likely a foreclosure will greatly harm your credit rating and your ability to get credit.
  • Have you considered alternatives, such as seeking a loan modification or a “short sale,” where the lender is asked to accept less than is owed on the property?
  • Can you rent out your home for an amount that would at least break even with the monthly mortgage payment, including taxes and insurance?

Online and storefront services have popped up to “help” desperate people default on their homes. Usually for a fee, they guide people through the paperwork, making it appear to be an easy, carefree procedure.

It is not easy, nor carefree. The decision to strategically default on a mortgage must be made after careful thought and consultation with experts.

Patty consulted with an attorney and accountant, as well as her financial planner before defaulting on her underwater mortgage. Rent on a smaller, more suitable house was half her monthly mortgage payment. But she acted “strategically,” first lining up the rental, before endangering her credit rating with a default. Renting also gave her the flexibility and freedom she craved, and the ability to eventually move to a new community and start a new life.

George, too, walked. At 86, George did not have the time to wait for the real estate market to recover. He needed his money now to pay the increasing cost of his care. The company providing his assisted living arrangements did not consider his credit rating when he relocated.