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Understanding Buy and Bail

You see new people moving into a house similar to yours in the neighborhood. You find out that they’ve got the house for almost half the price you paid for yours. This really upsets you.  Then you learn that they bought the house while they were owners of another house which was underwater. They are now letting their first home go into foreclosure.  You cannot believe this. How crazy can things get? Yes, this is the way Buy and Bail works.   

What is Buy and Bail?

“Buy and Bail” is a commonly used term which describes a situation in which a home owner buys a new home and then bails (goes into foreclosure) on his existing home. 

Basically, this concept involves strategic default planning.  If homeowners find that their current home doesn’t make financial sense and it appears a good time to buy another home, they sometimes consider Buy and Bail.

When does Buy and Bail cause problems?

Buy and Bail becomes a problem if you’re committing loan fraud during the process. A few years ago, the government attempted to prevent such frauds. You could not use rental income from a previous home for being eligible for another mortgage if the previous property had less than 30 percent equity.  Recently though, there have been instances of rental income being allowed without any equity in an existing home. 

Here are situations where problems arise:

Presenting an incorrect picture

If you tell your new lender that you will be renting out your old house and don’t actually plan to do so, there’s going to be an issue.

Also, if you state that the rent you’ll be receiving for the old house will be equal to the new mortgage payment, knowing very well that it will cover only part of the mortgage, you’ll face problems.

Recourse loans

Buy and Bail also becomes a problem when you have a junior lien on your old house that is a recourse loan. This means that your existing loan is not the original loan that was used for the purchase of your primary residence.  Then you’re stuck with the debt if you do not qualify for bankruptcy.

Tax Liability

Another scenario in which Buy and Bail becomes a problem is when the short sale or foreclosure of your old home results in tax liability.  Each real estate transfer is a taxable happening.  So if there was accrued interest or cash out on the old home, you must know whether there will be a tax liability in the event of the property being short sold or foreclosed later.

The Bottom Line

Buy and Bail is problematic. Though it appears tempting, the end can be quite bad.  It would stand you in good stead to remember that when things sound too good to be true, they are NOT true.  With a Buy and Bail, you might find yourself at the center of an ocean in a boat which doesn’t have a paddle.  I would suggest – stay away and stay safe.

If you’re seriously considering a Buy and Bail, do not proceed without seeking legal counsel. The consequences of Buy and Bail are very serious and should not be undermined.

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