A strategic default is when the owner of real property intentionally stops making mortgage payments and allows the property to be foreclosed. The benefits of doing this depend on the state in which the property is located. Each state has laws which govern a mortgage lender’s ability to collect a deficiency following foreclosure of property. A deficiency is the amount of the loan left unpaid after the property has been sold at a foreclosure auction and the proceeds applied to repaying the debt.
In some states mortgage lenders are unable to collect a deficiency from the borrower after foreclosure of property. However, Texas is a recourse state, meaning that the lender can collect a deficiency from the mortgagee after the property has been foreclosed but the lender is limited in the amount they can collect to the difference between the fair market value of the property at the time of the sale and the amount owed on the loan. This is an important limitation for the borrower, because property sold at auction is rarely sold at the fair market value of the property.
Whether a deficiency exists may come down to arguing over the fair market value of the property. Lenders will argue that the value of the property is less than the amount owed which will increase the mortgage deficiency. It may be necessary for the borrower to have the property appraised and dispute the fair market value with evidence in court to avoid a deficiency.
Chapter 7 bankruptcy should be considered as an alternative to a strategic default. This type of bankruptcy case will discharge the borrower’s liability for the mortgage deficiency as well as most other types of debts, such as payday loans, credit cards, hospital bills, and other unsecured debt.