By Farnoosh Torabi
Recently a distressed reader wrote to me wondering whether he should stay in his Detroit home or just give up and walk away.
His main gripe—like some eight million other Americans—is that his mortgage is far more than the home is currently worth. He isn’t building any equity and probably won’t at any point in the foreseeable future. So, should he just stop paying and let the bank deal with it?
My reader Michael (not his real name) has an extremely high interest rate of 8.6%, making his monthly payment roughly $1,850. Plus Detroit has the highest unemployment and foreclosure rates in the country, so a quick market recovery there is not likely.
“The area is starting to decline due to many vacant or vandalized homes with several break-ins, three for myself,” Michael writes. His credit is already poor, he says, and he no longer uses credit cards. He is married with two young kids.
More Reasons to Walk Away
More middle-of-the-road homeowners are grappling with the same issue as Michael. It's not necessarily because they can’t afford their monthly payments, but because they are “underwater,” owing more on their mortgage than the home is currently worth. They’re not building any equity and when time comes to sell, they’ll probably be in the hole.
The IRS has made it less of a tax pain to give up on your mortgage by now offering special tax relief for financially strapped borrowers who lose their home due to foreclosure. Previously, so-called “forgiven” debt was considered taxable income.
As the fixed-income team at Credit Suisse noted at the end of last year, “Should the downward spiral in home prices, neighborhood condition and equity deterioration continue, more and more mainstream borrowers are likely to walk away from their homes.” Credit Suisse also predicted that more than eight million mortgages would enter into foreclosure over the next four years. That’s about 16% of all mortgages.
In Michael’s case, he definitely needs to move to a safer neighborhood. Three break-ins in one month is more than enough reason to flee. But should he abandon his mortgage? Should anyone ever abandon their mortgage? That’s an entirely different question, so I asked a few experts to weigh in: Joe Brusuelas, a director at Moody’s Economy.com (Stock Quote: MCO); Gerri Detweiler, a credit advisor for Credit.com and Jon Maddux, CEO and co-founder of YouWalkAway.com, a site that helps distressed homeowners learn about their alternatives, such as ditching their mortgage.
When It’s OK to Walk Away
Even for Joe Brusuelas from Moody’s Economy.com, who is not a fan of walking away from a mortgage, ditching your mortgage sometimes make sense. But it’s an exception, not a rule, he says. “There may be a narrow range of conditions under which walking away from a home that is so far underwater is rational,” says Brusuelas.
Here are some of the factors our experts say are extremely important to consider before making your decision. In any situation you want to speak to a bankruptcy attorney.
1. Your Bank Won’t Help (and Won’t Chase After You). Bottom line: Banks don’t want to go through another foreclosure process. It takes time and money. But if saying you desperately need to modify your loan fails to earn you any material help, then you may have to take matters into your own hands and walk away. Before you do, make sure your bank has no plans to chase you down and sue you for “deficiency” claims, says Detweiler of Credit.com. Those claims, depending on your situation, could end up costing thousands and thousands of dollars. Some states, like California and Florida, now prohibit deficiency claims. In other states, some lenders are choosing not to go after defaulted borrowers because they’ve got too much on their plates. But others aren't so lenient.
“Until the statute of limitations is expired, I wouldn’t think I was in the clear,” Detweiler says. “[The lenders] may come after you in a couple of years after taking a deep breath.” Some attorneys recommend getting a signed letter from your bank stating it won’t sue you for deficiency claims.
2. You’re Not Able to Save. For a $1,000 fee, YouWalkAway.com guides you through the process of ditching your home. Of the 5,000 members who’ve signed up so far, many have decided to forgo their mortgage because they say they’re no longer able to save any money.
“They see [their home] as a major drain to their savings and cash flow in general. They don’t want to keep bleeding basically,” says Maddox, the CEO. If every payment on your mortgage is a step backwards from achieving your financial goals, a foreclosure, he says, may be a suitable path. Especially if you don’t see the area appreciating in value in the next five, seven or 10 years.
3. You’re OK with Damaging Your Credit. A foreclosure stains your credit report for seven years, much like Chapter 13 bankruptcy, which is a partial debt repayment plan. A Chapter 7 bankruptcy, which eliminates your debt entirely, sits on your credit report for 10 years. This means that for a period of time, you may have trouble getting a loan on another property.
“Ultimately, lenders make decision based on risk,” says Detweiler. “Lenders really shy away from serious negative items like foreclosure and bankruptcy.” It will take at least a few years before you can qualify for a new loan and your rates will be extremely high.
Another tip: Don’t let the potential consequences on your credit report decide between filing for a foreclosure or a bankruptcy. They’re both quite ugly. Instead, you should examine the bigger picture, figure out what your future goals are and what the best personal strategy may be for you. And talk to a bankruptcy attorney to weigh it all out. “The homeowner needs to focus on what is the best financial strategy for the next say, five years, versus trying to beat the credit scoring system,” says Detweiler.
4. You Need to Be OK With It. The decision to walk away from your home has been chastised by some in the press for being “immoral.” A contract is a promise, some critics argue, and therefore should be upheld no matter what. What’s more, foreclosing on your home potentially lowers the value of the neighborhood and hurts the economy.
Maddox, on the other hand, says there’s no moral obligation to keeping an unfavorable mortgage. Desperate mortgage holders should do what they can to help themselves get out of painful situations, especially when their bank won’t compromise. After all, he says, banks have no problem breaking contracts or writing off assets.
“If banks cut their bottom line by, for example, firing workers, they get applauded by shareholders. But guys struggling to pay for their kids’ college because their mortgage is too high, those guys get thrown under the bus and we say they’re dead beats, unethical and immoral,” he says
—For more ways to save, spend, invest and borrow, visit MainStreet.com.