“Buy and bail” is a phrase often used by real estate professionals to refer to the process in which a buyer attempts to buy a new property before they walk away from an old one and default on their previous loan. Often, the property they walk away from is an “underwater” property that is worth less than its mortgage, and therefore it is no longer desirable for the owner, the new property will most likely be a lower priced property with a more affordable loan. With house prices falling in many areas of the U.S, this is often a very appealing option for buyers.
Although this practice is considered a fraud if borrowers lie on the loan application, and many attempts have been made to stop this practice, the buyer is often driven by greed or desperation and finds no other solution but to “buy and bail”. If the buyer is able to get a new financing for the new house, he or she is taking a step to save his or her credit rating which can be greatly ruined by walking away from their previous loan.
Many attempts have been made by the two biggest U.S mortgage companies Freddie Mac and Fannie Mae to stop this practice. They have banned in most cases the use of rental income from an existing property to qualify for a new mortgage unless the first property has at least 30 percent equity. Additionally, they usually require reserves equal to six months of loan payments for both homes. Pete Bakel, a spokesman for Washington-based Fannie Mae said these measures have been helpful in blocking almost all buyers who attempt to buy and bail. However, the desperation of the buyers sometimes is stronger than the attempt to stop them from executing their “buy and bail” plans. Savvy buyers are sometimes able to cheat the system and find enough loopholes to get away with this.
“Making it possible to pursue people who do this particular kind of default would go a long way to addressing the buy-and-bail problem,” said Jay Brinkmann, chief economist for the Mortgage Bankers Association in Washington. To this date, only two-thirds of U.S states allow lenders to pursue a borrower after foreclosure by seeking a deficiency judgment allowing a lien on the new property for the amount owed on the previous mortgage. Furthermore, Mortgage lenders are also partly responsible for the “buy and bail” dilemma. Although some of them are responsible and try to get the complete truth from the prospective buyer, others simply do not try and all they care about is that there is enough income for the buyer to pay both mortgages.
According to brokers such as Collier and Meg Burns, senior associate director for congressional affairs and communications at the Federal Housing Finance Agency “People were holding on, hoping the market would turn around,” Collier, who won’t work with applicants who intend to go into foreclosure, said in a telephone interview. “But now they’re giving up because there’s no light at the end of the tunnel in places like Florida.”
Another raising concern reported by the New York-based Morgan Stanley in an April 29 report, is that about 12 percent of residential-loan defaults in February 2010 were the responsibility of homeowners deciding not to make payments even though they could afford to. Brent White, a law professor at the University of Arizona in Tucson said that people who choose to default typically have lost $100,000 or more in property value.
With this information – how would you view a strategic default? If a borrower can afford the payments, but opts not to pay because they are $100k, $200k or more underwater…is that right or OK? Would your answer be the same if the property was an investment (rental) property vs. a primary?
- Consider this before buying a foreclosure
- Foreclosure delay – bogus or justified?
- Housing Market Mess
- Some musing on “recovery”
- Walking away – the right answer?
Eric Burgess has written 75 articles on Mr. Mortgage @ Mason McDuffie Mortgage
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