Amy Kimbell is a 31-year old woman who is engaged to be married to Graham, a nice boy, who is 33 years old. Amy and Graham are young professionals who live in the Phoenix metro area. Each makes about $90,000/year.
Graham currently rents a small apartment for $800/month but the couple spends most of their time at Amy’s house. Amy purchased her house (2,200 square feet with a pool) in 2006 for $400,000 (this was the top of the boom real estate market in Phoenix). Amy currently owes $350,000 on the house and the estimated market value is $220,000 (she is significantly “under-water”). Amy’s monthly payment on the house is $2,400 including escrow.
Amy is considering a strategic default on her mortgage. Amy can afford her current house payment (in addition to her take-home pay, she also receives $2,000/month from a grandparent’s trust fund). If she walks away from the house, her credit rating will take a significant hit. However, her income, plus Graham’s (his lease is up next month) would allow them to rent a similar house for approximately $1,400/month or a much better house for the same amount they are currently paying. Amy is counting on the bank not pursuing her for the loan balance. In some states, lenders are prohibited from “chasing” borrowers for their money and are restricted to taking the house. In other states, lenders are allowed to sue for recovery of the loan balance but in bad times the lenders are often slow to respond or fail to initiate the legal proceedings. In most cases, during tough economic times, foreclosures are from borrowers without extra funds so banks don’t have the resources to file lawsuits against borrowers who, in most cases, are insolvent so they often do not pursue borrowers. Bottom line, Amy and Graham can shed $350,000 in debt and easily live in a rental house that is as nice (or substantially nicer). Additional (pro-strategic default from a lawyer looking to take advantage of the situation)
Amy is considering a two-stage strategy relating to her “under-water” house. For stage 1, Amy is considering working out an agreement with the bank to allow a short sale. A short sale is a when the bank agrees to allow the borrower (home owner) to sell the house for a market value amount that is less than the loan amount. Banks sometimes agree to this because the home owner will take care of the property until the property is sold. This might be acceptable to the bank (compared to the home owners who walk away after damaging the property or allowing the property to deteriorate in their absence). In this case the house could be sold for about $220,000 and the $350,000 debt will be “discharged” from Amy’s credit report. Amy’s credit rating will take a significant hit (but not quite as bad as the hit from scenario 1). Stage 2 is that Graham will make a competitive (~ $230,000) offer for the house through a realtor (without disclosing his relationship to Amy). If the bank accepts the short-sale offer of $230,000 from Graham, the couple will be able to continue to live in the house (Graham will own it) and now will only owe substantially less and have a much lower monthly payment.
What is your opinion on the each of the two scenarios. Are the behaviors unethical? Would you consider either or both of the scenarios?
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In my opinion, both the scenarios are unethical since they are based on concepts of deceit and causes harm to stakeholders also in the process. In the first case, the couple can get rid of the debt but the same would also impact the balance sheet of the banks. This debt would be borne by the Government and is indirectly financed from the money of the tax payers and funds that could have been used in development of the economy. As such, they are misusing the provisions of law to get benefit and this would have an adverse effect on the bank and the society at large...
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