MORTGAGE DEBT: STRATEGIC DEFAULT VERSUS BANKRUPTCY
A strategic default is a property owner’s decision to stop making payments to a mortgage lender and to allow property to be foreclosed. Whether a strategic default is a good idea depends on the property owner’s specific situation and the state in which the property is located. Each state has its own set of rules that govern foreclosure and the mortgage lender’s ability to collect a deficiency after foreclosure. A deficiency is the amount owed to a mortgage lender after a property is foreclosed. For example, if a house is foreclosed and sold at auction for $200,000 but the amount owed to the lender is $250,000, then the lender may be owed a mortgage deficiency in the amount of $50,000.
For the purposes of this article, I will be discussing how Texas law affects a strategic default. Texas is a recourse state, meaning that mortgage lenders can collect mortgage deficiencies. However, mortgage lenders are limited in their ability to collect a deficiency to the difference between the fair market value of the property at the time of sale and the balance of the loan in default. This is a significant limitation because properties sold at auction rarely are sold for the full fair market value of the property. For example, a property worth $200,000 may be sold for $150,000 at auction. The amount owed to the lender is $250,000. The lender will only be able to obtain a judgment for $50,000, which is the difference between the value of the property and the amount owed.
In practice, determining a mortgage deficiency is seldom this simple. Mortgage lenders will present evidence that the property is worth much less than what the homeowner thinks their property is worth. As a result, a home worth $200,000 may be found to have a much lower fair market value which in turn increases the mortgage deficiency. In order to contest the valuation of the property it may be necessary to hire an attorney and to have the property appraised, but there is no guarantee that the homeowner will be successful in proving the valuation of the home is higher, and this process can be expensive.
For some homeowners Chapter 7 bankruptcy is a good alternative to a strategic default. Chapter 7 bankruptcy is relatively inexpensive, it will completely eliminate a homeowner’s liability for a mortgage deficiency and it will address other debts as well, such as credit cards and medical bills. Before deciding to strategically default on a mortgage loan or to file Chapter 7 bankruptcy, homeowners should seek advice from an attorney with experience in these types of legal issues.
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