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Strategic Defaulters Can Redeem Themselves

King Solomon’s Proverbs emphasize the importance of knowledge – and the prudent application of that knowledge to rectify mistakes and reform a sinful way of living: “A man’s own folly ruins his life,” the king says in Proverbs 19:3. But learning and wisdom brings prosperity. In today’s world of income property investing, a number of homeowners who lost their houses to foreclosure in the housing collapse of a few years ago are being given another chance to prove themselves in the housing market. These so-called “strategic defaulters” are considered reasonable credit risks by lenders eager to boost mortgage processing.

Thanks to falling home prices and questionable mortgage lending, the crash of the housing bubble in 2008 plunged homeowners into crisis. Many of these hung on, fighting foreclosure as long as possible. But another group of owners, including some investors, simply opted to walk away from the mortgage entirely without trying to salvage the situation – a strategy that became known as the strategic default. Since lenders and, in “judicial” states, the courts, were clogged with foreclosure cases anyway, these owners faced little or no penalty for doing so, and most didn’t expect to be able to buy another home anyway.

But those expectations have changed. Even though lending standards have tightened considerably since those days of freewheeling mortgage lending that led up to the crash, a number of lenders are willing to take a second look at these strategic defaulters.

The reason, say housing industry professionals, has to do with a recognition that the housing crash was a unique circumstance that put otherwise credit-worthy people into a difficult situation – quite different from the profile of the habitually delinquent borrowers with poor credit across the board. That means that a mortgage applicant whose only credit blemish is a single mortgage default caused by the crash may well appear to be a better risk than an individual who has delinquencies on credit card accounts.

Even with lenders more willing to work with strategic defaulters, the process isn’t instantaneous. Many lenders require a waiting period after foreclosure before an applicant can qualify for another loan. Those periods vary by lender: for FHA loans, the wait is just three years, while for loans backed by Fannie Mae and Freddie Mac, it can be as much as seven. And private lenders impose their own, different time frames. And when a loan is granted, interest rates may be higher to offset risk.

Welcoming these victims of the crash back into the fold of homeownership has a number of effects on the housing market, with consequences for investors as well as residential buyers. Lenders large and small can profit from expanding the pool of borrowers. Competition increases for the supply of available homes on the market, and demand for rentals may decrease as these current renters acquire their own homes once again.

A recent article for CNBC reports that by 2014 over 1.5 million foreclosure victims will be eligible to return to the housing market – a number with the potential to make significant impact on the housing market. For investors working with Jason Hartman’s strategies for creating wealth in real estate, the return of the strategic defaulter may be a boon – or a bust.

The Solomon Success Team

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