Wednesday, October 28, 2009

Strategic defaults, deficiency judgments and bankruptcy

I have written earlier about "strategic defaults," by which homeowners intentionally stop paying their mortgage company even though they can afford the monthly payments. The owners intend to abandon the home to the bank because the home has declined so far in value that the mortgage debt far exceeds the value.

While this may seem like a viable option and a way to get rid of debt, homeowners in Pennsylvania must remember that the banks have the option of pursuing a "deficiency judgment" against the owner. Even if the bank forecloses on the home, the former owner remains indebted for the full amount of the loan less whatever the bank recovered by selling the home. The bank can pursue the former homeowner for the difference (or "deficiency"). Laws vary from state to state - and differences in state laws partially account for differences between states in the rate of "strategic defaults."

A former homeowner that is determined to avoid paying the deficiency can discharge any such claim by declaring bankruptcy, but there are pitfalls in this approach also. Both the foreclosure and the bankruptcy will create serious black marks against the former owner's credit (especially the foreclosure). A bankruptcy might result in the forced liquidation of some or all of the debtor's assets.

The bottom line is that you must be careful of financial advisors that present risky strategies that might not be tailored to Pennsylvania law.

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