The times are changing and some of my owner financing suggestions may no longer reflect current market assumptions.
Ruthless default or strategic default are terms used to describe borrowers who could continue to make their payments, who decide to stop making payments. The increasing number of such borrowers is driven by the many people, especially those in California, Arizona, and Florida who owe much more on their house than it’s current market value. Many of these people are so far “Underwater” loan modifications will not solve their problem. Many others have lost their jobs. Without a job there is no modification that will make a difference.
On one side of the discussion are borrowers who feel their loan is a promise they made and their ethics say you must honor your promises.
On the other side are those who say their mortgage is a business contract which can be broken by either party, subject to known penalties. (Bank gets the house, borrower gets their credit trashed.)
Lenders greatest fear is that a significant number of borrowers will change from feeling a moral obligation to repay to feeling justified in walking away from their loan in spite of the consequences.
A poster on a forum I read summed up the conflict nicely:
“Strategic default sounds unconscionable until you compare it to killing any chance of retirement, having difficulty putting food on the table, and having no prospect of being whole even if you follow the rules.”
If you sell your property with owner financing that makes you a lender! Since owner financing is frequently used for transactions where the buyers credit is questionable, where down payments are smaller than normal, or where the property is not financeable with a conventional loan, it is even more likely to have problems. That is not good in todays economic environment.
I strongly encourage everyone thinking of owner financing to search the internet for “ruthless default”, “strategic default” or other terms that come into use. Along with a lot of junk, you will find well written articles on the pros/cons of this solution from both the lender and borrower side. Each of you will have to decide how and if this will impact your owner financing decisions.
I thought this article describes current thinking very well.
{ 2 comments… read them below or add one }
Well I did it…..I “held paper” on the sale of my home five years ago.
It was less than a quarter of the sale price. I correctly reported it to the IRS as an Installment Sale.
My Buyer got into trouble last summer, due to financial overextension in general. He had purchased my home as a development property, not a primary residence. He offered me $.50 on the $1.00 for what he owed me and I took it.
My questions are: Do I 1099-C him? And how do I report that the Installment Sale is over? I know I report the portion I did receive, but what about the portion I forgave. I assume that when you report an Installment Sale and it shows the amount of money you expect to be receiving to make the sale price, that it carries forward in your records and the IRS is watching for it to be forfilled. In this case, it won’t be and I am wondering how I handle it.
Thank you for your help.
In these times I think you did the right thing by taking his offer. One of the investment advisers I heard years ago said the best advice he could give was never spend good money chasing money that was already lost.
Your other questions are good but the answers are “above my pay grade”. I’m neither a CPA or attorney; just a guy that did quite a few real estate deals over the years. The question I would have for a CPA is if your profit percentage changes. You calculated that when you reported the sale and have been making the allocation between profit and return of capital for the last five years. In effect, you now sold the property for less and I wonder if you can correct for that.
Thanks for the question. If you feel like posting the answer sometime I would enjoy seeing it.