You don’t have look far in mainstream media to find stories about strategic default. We’ve written about how strategic default is a morally defensible choice and about how we arrived in the current strategic default environment. This is an entirely different discussion that is aimed at people with two mortgages AND family members or friends that are in a position to lend a hand financially.
Buying the Note: An Alternative to Default
Consider the following example: Gordon Gecko has two mortgages on his home with principal balances totaling $475,000. The home, however, is only worth $375,000, and since Gordon’s investment fund recently imploded, he can no longer afford the monthly payments. As we’ve discussed in numerous articles on asset protection and strategic default, Gordon should walk away from the mortgage. But there’s a twist to this hypothetical. In this story, assume that Gordon owes $375,000 on his first mortgage (i.e. the loan he took out to originally purchase the house) and $100,000 on his second mortgage (i.e. home equity loan). Also, assume that Gordon has some wealthy friends on Wall Street who want to lend him a hand.
With these facts in play, Gordon now has a few new options. Of course, he can still choose strategic default and walk away. His other choice is to have his friends on Wall Street “buy the note” at a discount. That’s a fancy way of saying that Gordon can have his friends negotiate with the bank that extended the first mortgage in attempt to buy it for some amount less than $375,000. With all the toxic debt on bank balance sheets these days, that’s a very real possibility, though it could take some time and hard negotiating.
Foreclosure of the Loan
If Gordon’s friends are successful in obtaining the note from the original lender, the next step would be for them to foreclose on Gordon. Because the home equity loan–the 2nd mortgage–is legally inferior to the first mortgage, it would be extinguished after a foreclosure. In essence it would wipe out $100,000 of Gordon’s debt. So with the help of friends, Gordon can keep his home and owe less than the home is actually worth. Of course, it takes a lot of work, some willing and able friends (or family), and patience . . . but it can be done. As an aside, it helps to create a separate limited liability company to try to purchase the note, just because banks are more willing to discount notes for third-party investors than for a person already liable on the note or his or her friends.
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