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Sep 12, 2016 “Buy and Bail” is a very bad idea

Gary Sandler

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Published September 12, 2016

What follows is the story of an actual Las Cruces area homebuyer who purchased a new home a few years ago with the intention of living in it for quite some time. After residing in the property for just under a year, the homeowner received a terrific out-of-town job offer. He was elated and immediately began making plans to accept the offer, sell his home, and begin the next chapter of his life in a new city.

To make a long story short, it didn’t take long for the homeowner to figure out that his property had not appreciated in value enough to cover the costs of selling. In fact, it was worth slightly less than what he paid for it. Since he only made a small downpayment and financed almost the entire purchase price, he found himself in what’s called a negative equity position. Negative equity is where the balance of the mortgage exceeds the value of the home.

For those of you who haven’t had the privilege of owing more on your home than it is worth, the state of affairs is also referred to as being “upside down” or “underwater”. Add to the mortgage deficit the cost of selling the property, and our homebuyer’s total shortfall ballooned to almost $13,000. As you might have expected, our owner had little interest in writing a $13,000 check at closing.

The next order of business was to explore renting the property. Unfortunately, renting was not on the option list either because the market rent for his home would fall about $300.00 per month short of covering his monthly mortgage payment. Add in a yearly vacancy factor and a few bucks here and there for maintenance and management fees, he could easily find himself “feeding” his investment to the tune of $5,000 to $7,000 per year. Needless to say, he was no more enamored with feeding his investment month-by-month than he was feeding it all at once.

After pretty-much exhausting his choices, including refinancing the property, our homebuyer came to the conclusion that he really had only two remaining alternatives: Walk away from his investment and pay for the privilege sometime down the road, or remain in Las Cruces and forego the new job opportunity. Being a prudent person, he opted to stay put and dismissed entirely the notion of walking away from his home. Not all homeowners are as practical as this gentleman was, however. Some decide to abandon their current home and replace it with another using a technique called “Buy and Bail”.

In a nutshell, the Buy and Bail scenario is one in which a homeowner hatches a plan to purchase a home elsewhere (the Buy) with the intention of discontinuing making payments on the “upside down” or impossible-to-sell home that he or she is about to abandon (the “Bail”).

How do these folks get a loan for a new home when they’re barely able to hang on to their current home? They’ll often convince the loan officers that they plan to rent out the first house and use the rental income to qualify for the mortgage on their new home. In some cases, they’ll actually manufacture a bogus rental agreement and submit it to the lender as proof the home has been rented. In essence, the Buy and Bail folks try to qualify for a mortgage on a new home just as they stop making payments on their old home but before any negative reporting or foreclosure notices appear in their credit files or on the public record.

While Buy and Bail may seem like a good idea to some, there are serious financial and legal consequences for the homeowner, his community, and for any real estate professionals who might find themselves caught up in the process.

One of the most serious downsides to this practice is that foreclosure ruins a person’s credit rating.  Foreclosure filings stay in credit files for 7 years; making it difficult to qualify for new credit cards, auto and mortgage loans and even insurance. Then there’s the negative impact foreclosures have on the old neighborhood. Realty agents and owners alike can only sit on the sidelines and watch while abandoned homes pull down property values.

That’s not the half of it, however. The true downside to the “Buy and Bail scheme is the fact that submitting bogus paperwork to a lender in order to qualify for a mortgage is a crime and, in most cases, a federal crime at that!  Rather than risk being convicted of mortgage fraud and living at the Graybar Hotel for an undetermined length of time, homeowners should consult an attorney before embarking on such an unlawful scheme.

See you at closing.

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