Embracing Voluntary Foreclosure: A Strategic Financial Move
A voluntary foreclosure is an alternative where borrowers initiate the process themselves due to their inability to continue making loan payments on their property. By opting for this, they aim to avoid the more severe repercussions of involuntary foreclosure and eviction.
This contrasts with an involuntary foreclosure, which is pursued by the lender to reclaim a property to cover their losses. Voluntary foreclosure can be requested for both residential and commercial properties and is sometimes also referred to as strategic default, walking away, jingle mail, or friendly foreclosure.
Key Takeaways
- Initiated by Borrowers: Voluntary foreclosure starts when borrowers recognize they can’t continue making payments on their property loan.
- Credit Impact: While it affects credit ratings negatively, it is often less damaging than involuntary foreclosure.
- Financial Strategy: During the late 2000s subprime mortgage crisis, many borrowers opted for voluntary foreclosure due to underwater mortgages.
- Pre-Planning: Some borrowers prepare by taking new loans or credit before proceeding with voluntary foreclosure.
Understanding Voluntary Foreclosure
Voluntary foreclosure can be a viable option for borrowers unable to manage their mortgage. However, it significantly affects credit rating and poses challenges in securing future loans or renting homes. Nonetheless, this self-initiated action is generally less detrimental compared to involuntary foreclosure.
Before proceeding, many borrowers manage to open new credit cards, secure car loans, or obtain mortgages. Lenders might find a borrower’s voluntary foreclosure request beneficial since it simplifies and speeds up the process of reclaiming property and recovering debts.
Common Situations Leading to Voluntary Foreclosure
Factors that may prompt a voluntary foreclosure include unexpected job loss, lifestyle financial imbalance, or shifts in the housing market affecting variable mortgage rates (such as those with adjustable-rate mortgages).
Deed in Lieu of Foreclosure: A Frequently Used Tool
One commonly exercised method for voluntary foreclosure is the deed in lieu of foreclosure. Such processes vary depending on the lender’s policies and state regulations.
Pros and Cons: Weighing the Decision to Voluntarily Foreclose
Pros of Voluntary Foreclosure
- Financial Release: Much faster and uncomplicated escape from debt obligations compared to involuntary foreclosure, offering relief if the property value is significantly underwater.
- Lower Credit Impact: Often has a milder impact on credit scores than involuntary foreclosure.
- Reduced Stigma: Less social repercussions compared to involuntary foreclosure.
Cons of Voluntary Foreclosure
- Potential Deficiency Judgments: Some states might still allow lenders to pursue the borrower for any remaining loan amounts post-foreclosure sale.
- Credit Damage: Voluntary foreclosure will still negatively affect the borrower’s credit score, impacting future ability to procure loans.
- Employment Risks: Certain jobs might deem individuals with foreclosure history as ineligible.
Voluntary Foreclosures During the Housing Crisis of 2007-2009
The landscape of voluntary foreclosures changed drastically during the late 2000s. Post-2007, plunging housing prices and underwater mortgages pushed numerous borrowers towards voluntary foreclosure. States like California, Nevada, and Florida saw a significant proportion of mortgages becoming underwater.
Influential Factors and Strategic Alternatives to Consider
When contemplating voluntary foreclosure, it’s important to explore all potential alternatives, such as loan modifications or short sales. For instance, Fannie Mae imposes a four-year waiting period before granting a new mortgage post a deed in lieu of foreclosure.
By understanding the underlying nuances of voluntary foreclosure and strategizing carefully, borrowers can navigate this challenging financial terrain more effectively.
Related Terms: strategic default, deed in lieu of foreclosure, loan modification, short sale, adjustable-rate mortgage (ARM).
References
- Fannie Mae. “B3-5.3-07, Significant Derogatory Credit Events — Waiting Periods and Re-establishing Credit (08/07/2019)”.
- Federal Reserve Bank of San Francisco. “FRBSF Economic Letter-Underwater Mortgages”.
