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Real Estate “Buy and Bail” – Financial Smarts or Mortgage Fraud

A new real estate strategy is emerging in real estate markets hardest hit by falling  home prices and rising foreclosures. This strategy has been called “Buy and Bail”. The Wall Street Journal article Some Buy a New Home To Bail On The Old gives a good description of the Buy and Bail process. Fortunately, the Pensacola Real Estate market was not hit as hard as other Florida markets by the recent drastic price declines in property values.

Buy and Bail is a very simple strategy, but also very sketchy. Basically, a homeowner who paid a lot for a home when the market was at peak levels now decides to buy another home at a much lower market value and walk away from the original home, leaving the lender holding the bag.

Here is a brief example of the process. Foreclosure_next_Exit_Sign

Bill borrowed money to buy a $400,000 home at the heightof the market. That home is now worth only $200,000 fair market value.

Bill feels cheated by this down real estate market and wants out of the $400,000 mortgage.

Bill has good credit and some cash reserves.

Bill buys a comparable home for only $200,000 in the down real estate market.

Bill walks away from the home with $400,000 mortgage and leaves the bank to foreclose on the property.

Bill’s credit is damaged, and the bank stands to lose over $200,000 on the deal.

Mortgage Fraud?

Many lenders and real estate agents call this mortgage fraud. The homeowners are taking advantage of mortgage-lending practices that allow them to buy a new primary residence before their existing residence has been sold.

In some cases real estate agents and brokers are actually participating in this process. They are coaching homeowners through the buy-and-bail process.  “It’s just a business decision,” says Linda Caoili, a Sacramento real-estate agent who has worked with people who are considering walking away from their mortgages. “If you’re upside-down $250,000, why would you keep it? It just doesn’t make sense.”

In this situation, some homeowners opt to ‘buy and bail’. These owners are using their good credit rating to buy a second home at a lower price, assuring the lender they’ll rent out their first home. Then they just walk away from the first home, and leave the lender holding the bag.

To be sure, walking away from a mortgage, even if legal, has plenty of drawbacks:

Borrowers lose the ability to take out unsecured loans, since foreclosures can stay on a credit report for seven years.

In some states, lenders can sue for assets, including a new house.

Here Comes Uncle Sam

Now the government intends to step in and put an end to “buy and bail”. Under revised Fannie Mae guidelines, loan applicants who claim they will rent out their first home will have to produce supporting evidence, including an executed lease agreement. Borrowers also will have to prove that they can pay the mortgage, property taxes and insurance for both residences. The guidelines will make an exception only for borrowers who have at least 30 percent equity in their current home.
Fannie Mae, the government-sponsored mortgage underwriter, recently revised the amount of time borrowers with a foreclosure must wait to receive a home loan to five years from four. Proposed Fannie Mae guidelines, which could take effect later this month, also would require those borrowers to make a 10% down payment and meet a minimum credit score after the five-year period.

Note that the buy and bail strategy is not common in the Pensacola real estate market. Home values have not dropped as drastically as in other areas of the country where this technique is more used.

How much is it worth to lose your good credit rating?

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