Jim Porter: It is OK to walk away from your home loan
Special to the Sun
TRUCKEE/TAHOE, Calif. and#8212; Let me get right out there and say that it may be all right for you to walk away from your and#8220;upside downand#8221; home loan.
Youand#8217;ve heard of a Strategic Foreclosure, that is where the homeowner is able to make the monthly payments, but chooses to stop doing so, a so-called strategic default, leading to a Strategic Foreclosure.
Letand#8217;s say that Jim and Marianne purchased or refinanced a home in 2005, 2006 or 2007 for $600,000. They borrowed $500,000, and now the home is worth $350,000, so they are and#8220;upside downand#8221; $150,000. Their loan exceeds the market value by that much. That is the scenario I am seeing with clients every week.
There are more than 17 million homes nationwide that are and#8220;underwaterand#8221; or and#8220;upside down.and#8221; That is why there are close to a dozen foreclosure notices in every issue of the Sierra Sun and#8212; all local property owners.
Property owners and#8220;underwaterand#8221; with their loan have several options. You can keep paying. For some that means you exhaust your savings. You can try and pay down the loan. Easier said than done. The best may be to modify your loan.
Modifying your loan makes the most sense, but most lenders are overwhelmed with loan defaults and not competent at handling them and therefore make bad decisions with borrowers. Oops, did I say that?
Most of my clients that ask their lenders about loan modifications are told they must stop making payments for three or four months, and#8220;then we can talk about a loan modification.and#8221; I.e., the rationale being, if you are still paying on the loan, there is no reason for the lender to entertain a loan modification and#8212; which could include a principal reduction (that will almost never occur) or an extension of the term on the loan or a reduction in interest to market rates. To complicate matters, the and#8220;right handand#8221; of the lender tells you to stop paying, then the and#8220;left handand#8221; sends you a notice that you are in default and notifies credit agencies, which results in increased interest rates on your credit cards. Hmm. Something wrong with that picture.
To qualify for a loan modification, you may have to show a and#8220;hardship,and#8221; so you send in a package of financial information. You fill out the forms, send them in. The lender and#8220;does not receive them.and#8221; You resend them. The lender does not receive all of the documents. You resend all of the documents. Finally after several months you learn you donand#8217;t qualify for a hardship. At no time does the lender return your calls. That is the standard nightmare according to my clients.
At some point you grow weary of trying to modify your loan and talk to the lender about a short sale, where you find a buyer for your property and the lender agrees to clear title to the property upon payment of an amount that is less than the loan amount owed to the lender. You generally have to qualify for a and#8220;hardshipand#8221; to complete a short sale, going through the same frustrating experience as when you were trying to modify your loan. Many lenders will not sign off on a short sale, unless, you the borrower, agree in writing that you are responsible for the short fall in the loan, the difference between the price the lender gets when you sell and the higher loan amount. I seldom recommend to clients that they do a short sale when the lender requires them to acknowledge they still owe the unpaid loan balance. The lender will come after you.
You can offer a deed-in-lieu of foreclosure to the lender, but they will not accept it.
So there you are, having failed to accomplish a loan modification, having balked at a short sale because you couldnand#8217;t find a buyer who could wait patiently for months and months while the short sale was processed by the lender, or you didnand#8217;t meet the hardship test, or the lender required you to acknowledge after the short sale that you still owed more money.
Donand#8217;t forget that after a short sale or a foreclosure you may be sent a 1099 for and#8220;forgiveness of debtand#8221; income, although there are exemptions for primary residences.
Some borrowers cannot continue paying on their loans. They do not have the money. So if they are unable to accomplish a loan modification or a short sale, they will probably be foreclosed upon.
If you technically can afford to keep paying your and#8220;upside downand#8221; loan, should you continue doing so or should you consider stopping your payments, which will result in a Strategic Foreclosure?
Let me initially say that you should have no guilt or remorse about not making payments to your lender. No one likes to default, but your mortgage is a contract and#8212; a legal document and#8212; not a moral promise. The deed of trust has language in it that should you default, the lender can take back your property. That was the agreed deal. Get over the perceived negative social stigma-at least that is my advice.
Things to consider before stopping your mortgage payments are how much upside down are you, how long do you think it will take for your property to increase in value to be equal to the loan balance, what is the cost of renting a home, do you passionately or desperately need to continue living in your home, and how important is your credit rating-because you will take a major hit-probably in the area of 250 to 350 points. For many, by the time they are talking about a foreclosure, their credit is already tanked.
Another disadvantage of a foreclosure is that your name as the borrower will be in the legal notices in the newspaper as the lender publishes notice of the foreclosure auction. If you owe payments to a homeowner association, any assessment lien will be wiped out following the lenderand#8217;s foreclosure, but the HOA obligation remains yours.
If you have a second loan, it gets very complicated as and#8220;the secondand#8221; obligation may survive and#8220;the firstand#8217;sand#8221; foreclosure.
If you are considering a short sale or foreclosure, talk to your accountant. Factor in the tax liability of the and#8220;forgiveness of debtand#8221; income, the loan amount you did not have to pay because of the short sale or foreclosure, which can be horrendous. There are exemptions however if the loan was for a primary residence.
Stopping payments on your loan is an important decision with potential pitfalls and unintended consequences. Many factors weigh into that decision, but sometimes foreclosure is better than continuing to dump more money down a black hole. Sometimes you need to get on with your life.
There are online reading materials on foreclosures and Strategic Foreclosures, as well as short sales and loan modifications, and how they effect your credit rating. Read everything you can get your hands on.
Fanny Mae, the government-backed lending giant, is supposedly considering rules to prevent strategic defaulters by making them ineligible for a new Fanny Mae-backed mortgage unless the borrower made a good faith effort to work with their foreclosing lender.
Remember, if your lender forecloses on your property by the usual Notice of Default and Notice of Trustees Sale, as is done about 99 percent of the time in California, the lender may not come after you for the deficiency, the loan short-fall you did not pay, but as noted the lender may send you a 1099 for forgiveness of debt income. (In Nevada you have to worry about a lenderand#8217;s post-foreclosure deficiency lawsuit).
Todayand#8217;s column covers a complex legal area and#8212; so be careful. Work with qualified experts.
Jim Porter is an attorney with Porter Simon, with offices in Truckee, South Lake Tahoe, Incline Village and Reno. He is a mediator and was the Governorand#8217;s appointee to the Fair Political Practices Commission and McPherson Commission, both involving election law and the Political Reform Act. He may be reached at email@example.com or at the firmand#8217;s web site http://www.portersimon.com.
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