Strategic Default: Mortgage Deficiency Judgments and Asset Protection

More and more clients have questions about putting their assets into protective structures prior to strategically defaulting on one or more mortgages.  The reason is that some lenders are beginning to file lawsuits to collect deficiency judgments.  A deficiency is simply the difference between what is owed on a mortgage and what is obtained for the mortgaged property at a foreclosure sale.  In essence, a deficiency suit is a suit by a lender to recover shortfalls.

Protecting Assets Prior to Default

The Wall Street Journal recently published an article on this topic: House is Gone but Debt Lives On

The key observations from this article are that:

• While deficiency claims are still relatively rare, banks are pursuing them with more frequency.  In one Florida county, for example, deficiency suits have increased by 34%.
• Credit union and smaller lending institutions are much more aggressive than the “too big to fail” banks when it comes to pursuing borrowers for deficiency judgments. (It seems the old banker’s addage “know your customer” has been turned on its head–KNOW YOUR LENDER!)

A number of “experts” have predicted that banks will eventually become much more aggressive when it comes to pursuing deficiency claims.  We have no way of knowing whether or not that is true, but one thing is certainly true: Banks and other types of lenders are much, much more likely to pursue you for a deficiency if (i) they believe that you have assets to pay a deficiency, or (ii) they believe that you can afford to continue paying your mortgage but are, instead, choosing to shift the “loss” to the bank by walking away.

Asset Protection Tactics for Strategic Default

The worst case scenario is that a lender does obtain a deficiency judgment against you and then later sells that claim to a collections agency.  Collections agencies are relentless, and many of them will not stop pursuing your assets until:

• The claim is paid,
• They have repossessed your non-exempt assets (e.g. certain automobiles), or
• You file for bankruptcy.

Of course, prior to defaulting, there is no way to know whether or not your lender will pursue a deficiency, but you can do a few things to make yourself less attractive as a deficiency candidate.  For example, if you are preparing to default on an investment property but you live in a state with favorable homestead laws, you can pay down your primary mortgage.  Other options include moving assets into exempt asset classes (e.g. ERISA retirement accounts), or putting assets into a fully developed asset protection strategy.