Q: I’m underwater on my present home, and I’m seriously considering walking away. My credit rating is terrible. I have a guaranteed annuity income of approximately $2,000 per month, and I’m self-employed with an income of approximately $15,000 per month gross. I have approximately $100,000 in my cash accounts.
What is my best-case scenario as far as purchasing a home in the future, or is it unlikely that I will be able to purchase a home again? I’m not sure I want to put everything into a home at this stage of my life, as I’m almost retired.
A: Though the news reports during most of this year have trumpeted the recovery of the real estate market and home values in most places, you are definitely not isolated in your plight. The fact is that millions of American homeowners are still underwater, meaning that they owe more on their homes than the properties are currently worth, though hundreds of thousands get their heads above water every quarter home values continue to rise.
Walking away and washing your hands of a "bad" mortgage and an upside-down home can be very tempting, especially if you feel the fatigue of having waited more than five years for the real estate recession to set your home’s value to rights. But think carefully before you default on your home loan and abandon the property.
1. Explore the full set of motivations and problems you think walking away will solve for. Many homeowners who are tempted to walk away don’t quite realize that it is not the panacea it seems. A walk-away is an unfortunately drastic way to try to solve problems that may or may not actually be resolved as a result. So, ask yourself: What’s your top motivation(s) for thinking about walking away? Consider, at least, these issues:
- Are you looking to resolve the underwater issue?
- Can you afford the mortgage payments?
- Is the home still functioning well for your lifestyle, and do you think it will continue to, going forward?
Walking away does solve for the problem of being unable to make your monthly mortgage payments. That said, you don’t say you are unable to make them and, in fact, it sounds like your monthly cash flow situation is in pretty good shape.
On the underwater issue, walking away definitely locks in market losses that might be recovered if you held onto the home while the market continues to improve. To get a better understanding of your home’s prospects for recovery, you have to understand your local market and economy, as well as getting clear on precisely how much you owe on the place.
If you are nearing retirement and need to relocate, or you find that the home is simply no longer functional for you (e.g., it has four flights of stairs and your mobility is limited), walking away from the property is one way to divest of it, but selling it via a short sale is the method I would recommend you try before resorting to a full-blown strategic default.
2. Get a full understanding of the potentially traumatic consequences of walking away. Walking away is traumatic for everyone who does it. At a minimum, strategically defaulting homeowners find themselves having to find another place to live with impaired credit, and without the surprisingly major tax advantages of the very mortgage that so burdened them before.
However, you might have a unique set of circumstances that renders walking away especially concerning: your income, business and cash assets. In some states, there’s something called the "one action" rule, under which your lender can foreclose on your home or sue you, but cannot do both. In those states, lenders and servicers almost invariably take the house and leave the borrower alone.
Beyond that, all of these rules relate primarily to your first mortgage and any subsequent mortgages that you took out to purchase the home or refinance the purchase price.
If you took out a second or third mortgage or even a home equity line of credit (HELOC) and pulled cash out against your home’s equity, that mortgage will be left unsecured if you walk away, and the first lender takes the house. The cash-out loans are not prohibited from coming after your assets — including your cash and your business — by the first lender’s foreclosing on the property. Long story short: You could end up with a lawsuit or other attempt at collecting these junior loans against your relatively strong net worth.
Finally, there are tax considerations at issue, as well. Normally, a homeowner is charged with income taxes on any mortgage debt that is forgiven or written off by his lender through a foreclosure or short sale. There is currently an exemption in place, so that those income taxes are not charged, under the Mortgage Forgiveness Debt Relief Act. This exemption is set to expire at the end of this year unless Congress acts quickly to extend it — something President Obama has already requested.
In any event, your mortgage debt on your first and any other purchase money mortgages is not considered forgiven unless and until your home is foreclosed, which would almost certainly not happen this calendar year. So, in any event, you should be consulting with a tax adviser and possibly also a local real estate attorney who can flesh out all the implications of walking away before you make a decision about whether or not to do it.
3. Understand the impact of a walk-away on your future homeownership prospects. In terms of your future purchasing power if you do decide to walk away, many mortgage programs will start to become available to you in the three- or four-year post-foreclosure time frame.
However, if you end up with an unsecured cash-out junior loan, you will also likely have to resolve that by settling with the lender before you can qualify for another home loan, as it will show up as an outstanding, delinquent debt until you resolve it. This, in my opinion, is one of the most compelling reasons to do a short sale versus just walking away; in a short sale, the junior lenders often agree to take a very small amount of cash from the proceeds of sale to extinguish the junior loan(s). In a foreclosure, those junior loans are often still hanging around for years to come.
I’ve heard many folks facing this situation simply avow to be renters for the rest of their lives. But at your income level, once you experience a year or so of income taxes with no mortgage interest deduction, or some of the less than savory components of being a renter that you are just not used to, you will almost certainly at least consider buying a home again.
So, I’d urge you to talk with a tax adviser, a local attorney, and real estate and mortgage professionals you trust to fully understand your options, the many moving parts of the decision whether or not to walk away, and the impacts of either decision on your future as a homeowner, before you make any move.