Strategic Defaults Are Not “Illegal”

Hypothetical: Microsoft founder Bill Gates owns a rental home in Arizona which is “underwater” because the value of the home is less than the amount owed on the mortgage used to buy the home.  Bill Gates intentionally stops making the mortgage payments, and the mortgage lender forecloses.

Issues: Does Bill Gates have any personal liability for the deficiency after foreclosure?  Is this intentional default by Bill Gates on the mortgage loan, i.e., strategic default, “illegal”?

Discussion: Prior to 1971 all home foreclosures in Arizona were judicial foreclosures of mortgages, meaning that  the mortgage lender was required to file a lawsuit, personally serve the buyer with the lawsuit, and have a judge order the sheriff to foreclose on the home.  Even after the sheriff conducted the foreclosure sale of the home, usually on the courthouse steps, the homeowner would have up to six months to redeem, i.e., get the money to buy the home back.  (Many states such as Florida and New York still only have judicial foreclosures of mortgages.)

In 1971, however, Arizona adopted non-judicial trustee’s sale foreclosure laws to establish procedures for the foreclosure of the newly-created deed of trust.  (This newly-created deed of trust generally replaced the mortgage as the document used in the financing of homes and other real property.)  These laws made the foreclosure process less time-consuming and less expensive by permitting mortgage lenders to foreclose a deed of trust without going to court.  Instead, trustee’s sales could be conducted by attorneys, title companies, or real estate brokers at locations other than the courthouse steps, e.g., in their offices, in little more than 90 days after the recording of the notice of trustee’s sale.  Additionally, the homeowner no longer had the right to redeem after the foreclosure sale.

These laws do not have a requirement that the homeowner be financially unable to make the mortgage payments in order to have the protection of the anti-deficiency statutes, and these laws protect all homeowners, including investors who own homes.  In other words, if Bill Gates owned a rental home in Arizona he would still be entitled to the protection of the anti-deficiency statutes, i.e., no personal liability for the mortgage loan used to purchase the home.  Although Bill Gates may breach his contract with the mortgage lender to pay the mortgage loan, Arizona law says that Bill Gates has no personal liability for this breach of contract.  Therefore, there is nothing “illegal” about a strategic default.

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