I’ve been reading a lot about anguished homeowners recently, who’ve been whipsawed by the subprime crisis and are now mulling their future. In some spots in California, things haven’t been too pretty with the real estate market, thus leading to a rise in foreclosures. And just as easy credit flowed easily not too long ago, fueling the rise in subprime mortgage and “no money down” loans, we’re now seeing the consequential rise in yet another disturbing trend: people simply deciding to walk away from their homes.
I can’t imagine what it’s like to face the prospect of losing your house. It’s a financial quandary that has many possible solutions that can depend on your specific situation. If I were in such a position, how would I go about figuring out what to do? I thought I’d put together some arguments and reasonings that go behind making such a huge financial decision — the decision to foreclose or to walk away from one’s home and mortgage.
Making The Decision To Foreclose
How you decide to resolve your mortgage issues may depend on your personal circumstances, so read on for some points to consider while making your decisions.
Why Would You Consider Foreclosure?
- Foreclosure may seem to be a more attractive option for those people who were caught in the subprime mess as holders (victims?) of 0% money down loans. This is because they have less money on the line — with no equity or no cash tied to your home, you may feel less obliged to hold on to your house.
- People have different reasons for owning a home. Those who bought homes for investment purposes will have different financial expectations as those who bought homes as primary residences. An investor looking for a quick buck will find it especially tempting to dump a house when faced with the possibility — or worse, the reality — of loss.
- If you can’t sleep at night and you really just want to bite the bullet and get things over with, then you may be a candidate for “walking away”. Though there are certainly ways you can work things out with your lender, it may be the case that you’d rather avoid the hassle and prefer to face the consequences (bad as they may be) of foreclosure and having this on your record.
- In some states, like California, once you “walk away” from your house, your lender cannot pursue you for additional funds. This may be a relief to some people who feel pressure and are in deep financial distress.
- Some mortgage experts have stated that foreclosure is not as devastating as you may think. For instance, you don’t need to declare bankruptcy, which is a different animal altogether.
- Even with foreclosure, you may be able to restore your good credit standing sooner than you think: think one or two years rather than the often mentioned seven to ten year process. How so? Supposedly, though a foreclosure is a mark on your credit report that stays for seven years, its true effects are mitigated over time: if the rest of your finances are positive, your payments are current and you have no other problems with your status, then your credit score can return to a decent range (e.g. 600’s – 700’s).
- You may have leverage: banks don’t like to foreclose — each bad loan costs them an estimated $40,000. This has encouraged troubled homeowners to apply pressure on their lenders by strong-arming these lenders into considering reducing their mortgage principal (in line with current appraised values). When backed into a corner, these homeowners threaten to “walk away” and foreclose, hoping that their banks will cave in to their demand of lowering their mortgage obligations.
Why Should You Avoid Foreclosure?
At this point you may think that foreclosure is sounding more and more like a decent proposition; can waiting seven years to clean up your credit really be that bad? You may actually need all that time to begin saving for yet another shot at another house down the road anyway! But before you start mailing in your house keys (to your lender), you should think twice before jumping the gun, and hear out the following points:
- Most credit advisors and services discourage delinquent homeowners from foreclosing. The prevailing financial wisdom is that you should do everything in your power to avoid foreclosure. There are many more options you can consider before taking the radical route. By communicating with your bank or lender, you may find a better solution to your woes, one that is superior to foreclosure.
- There is that obvious stain to your credit once you foreclose — it goes on your credit report for at least seven years. Once your credit gets hammered, your future loans and credit use become a much more expensive matter (check out how your credit scores affect your loan rates and how interest rates are hiked up for those with unfavorable credit), or worse, this can affect your ability to apply for any form of loan, insurance, employment or even housing!
- Fannie Mae is cracking down on borrowers who are contemplating on walking away from their obligations. Fannie now mandates that if you foreclose, you’ll have trouble getting another mortgage down the line. It will take you five to seven years before you can qualify for another mortgage through Fannie Mae, or three years, if you happen to have “documented extenuating circumstances”.
- If you foreclose, you’ll find yourself with stricter requirements in order to qualify for your next mortgage: you’ll need at least 10% for a down payment and a minimum FICO credit score of 680.
- Other problems you’ll be grappling with if you walk away? You’ll be facing federal income tax issues. You’ll still owe income tax on your unforgiven mortgage loan balance. Whereas if you work out a loan reduction/modification plan with your lender, any portion of your loan that is forgiven may escape tax liability.
- Once you’ve got a foreclosure on record, future applications for mortgage loans will be scrutinized in much more detail and will be subject to manual underwriting. Your loan application may take more time as your finances go through a microscope.
Clearly, foreclosure is one of the most stressful financial situations to be in, but this should really be your final option. Such a huge matter requires careful analysis and understanding of all the alternatives and the effects of your decisions. To those who have concerns about their home loans, I’m hoping this piece is able to provide you with some food for thought to consider as you evaluate your mortgage matters.
Image Credit: A foreclosed home for sale. (PAUL J. RICHARDS/AFP/Getty Images)
- Stock trades: Free stock trades from Zecco, Cheap stock trades from TradeKing, Stock news and Investment info at INO TV Free, No cost Trend Analysis for stocks
- Earn top returns: FNBO Direct [1.90%], HSBC Direct [1.65%], WTDirect [1.76%], E*Trade Bank [0.95%], ING Direct [.25% to 1.65%]
- Cash bonus: Discover More [$50], American Express [$25], Lending Club [$25]
If you enjoyed this post, you can get free regular updates through our RSS Feed, or you can have our latest posts delivered to your email inbox by supplying your address here. Your address will only be used for this purpose, and you can unsubscribe anytime.
{ 4 trackbacks }
{ 25 comments… read them below or add one }
Interesting. I find it odd that mortgage lenders would agree to lend to people who have no equity in the house and have the option to walk away. Pretty risky business model.
Mike
I think more homes are going into foreclosure than need to be going into foreclosure. Currently Countrywide is looking at an avalanche of lawsuits over improper procedures, bad record keeping (or no record keeping),and other flagrant violations. Lenders are slow to renegotiate and quick to foreclose. I do think we will need government intervention and soon, or it will get much, much uglier.
Thank you so much for publishing this article. I am in a situation where I’ve been considering foreclosing on two houses I own in Las Vegas. Your article has given me a good overview of my options and a better idea of what the consequences would be. Thanks again.
Melanie
Hi,
I deal with lenders every day and some of the statements are true but there are some gaps that need to be filled.
Lenders have tightened the guideline now and if you want a new loan you will require 20% down…. except FHA where they can still do 3% in some cases.
THe biggest challenge is even if the lender decides to ‘modify’ your loan you are only putting a band aid on a much bigger problem.
lets look: You are in default, you have missed 3 payment @ $2500 and you owe the bank loan to the amount of $250k and the recent sold comparables in the area are $225k.
You want to modify or refinance the loan. You now owe more than the house is worth. Re-FI will only refinance up to 70- 75 % MAX most will be 65%-70%.
So lets say a magic wand came out and you managed some how to qualify for a re-fi you would get $175k………….. but in order to close and get the new re-fi you would need to put down $75K. NOw if you had $75k my guess is you wouldnt be in default … right?
so the re-fi is out.
The next thing is a loan modification or a forbearance plan.
again you need to qualify. Has the reason for your default been erased, i.e you lost your job and now you have a new one, you fell ill and now you are all better?
If the reason for default has not been rectified then they will decline the modification.
SO lets say you pass that test and you get the modification adn your new payment is only $1700….. few thats a relief…. but what happend to the rest????? yes the other $800 ?
it goes on th eback end of the loan. you still owe it.
so after 12 -18 months ( the typical amount of time for a modification) you decide to sell the house and get something else as you know the payement is going to go back up to the $2500 at least.
so now you owe $250k for the original loan PLUS $7,500 for the payements you didnt make PLUS $ 14,400 to make up for the reduced payments you have had for the past 18 months.
lets look at th enumbers again. you now owe
$271k on a house that is only worth around $210k.
So in order to close the house you need to bring 70k to the table , plus commissions, plus closing costs which will equate to around another 6-9% which means you need to sell the house at $ 296,371.00 in order for you to walk away without a penny out your pocket.
And that aint going to happen anytime soon.
but there is an alternative.
what if you the same owe $250k and you are in default.
we know you cant sell it for what you owe.
what we then do for our clients is negotiate the debt with the bank and get them to take less than what is owed in order to sell the property.
with the negotiations we can pay off the house, pay the closing costs, and pay the commissions. you will be zero out of pocket and your credit will not have a foreclosure on it. so you can once again become a home owner later on.
this will allow you to move into rental and rebuild your life without the added pressure of having an overleveraged house.
we help around 150 homeowners a month.
hope this helps.
I had to foreclose too in Vegas. I guess reading this puts stuff into prospective so I don’t have to go through this again.
Thanks
I personally feel foreclosure is something both lenders and borrowers should avoid. Lenders often don’t want to foreclose because of the simple reason that it costs them a lot.
As for borrowers, they need to avoid it or else their credit would get a big hit. Also, quite obviously they’ll lose their homes. So, the best thing to do when one is in default, is to approach the lender and request for a foreclosure prevention option when a person is in default.
There are several options to avoid foreclosure but one has to choose the option that suits him the best. A rundown of each of the 17 foreclosure prevention options are available at http://www.mortgagefit.com/foreclosure/17ways-avoid.html
Regards,
Jessica.
Jessica, I don’t think people worry too much when they are about to be foreclosed on. It normally is the end of the road and it will be a while before they can get back to where they where. Banks just want their money back.
I went to foreclose my personal loan from ICICI Bank. They charged me damn 5%
Steve makes a great analysis of a scenario that most people fall under.
At the end of the day, one should try to avoid letting their house go into foreclosure.
It all starts with being able to manage their finances well.
Well, the best way to avoid foreclosure is to be prudent in the first place. One might want to check out Zillow or Trulia (or other web sites that do analysis of real estate prices) before committing to a purchase. This way, one will not price themselves out of the property sales market.
Ed: Thanks for your comment, I’ve edited it slightly because I don’t allow the use of key words/links in comments.
Well, many foreclosure homes need some degree of renovation work. Know ahead of time how much you are willing and able to do before you commit to more than you can handle.
Foreclosures are happening left and right but it doesn’t mean the end of the world for you and your personal credit. You can always seek help from professionals in the industry. Can’t hurt.
hi steve thanks for the info on loan modification, I am going to give it a try
I am not late on my loan at all but I am wondering how to recoup over 100k in equity that was lost with these foreclosures in my area. I feel like it would be a better financial plan to take about 6 months to finally get kicked me out (foreclose) which I would save about $3900 a month = $23k in cash and once I get out and rent a place for about $1900 less and save that each month. So in a year I would have about 35K in the bank. With the economy the way it is cash is king, so why not? Thoughts/Feedback?
Doug,
If you’re planning to foreclose, there are of course, consequences — which is the effect on your credit. You may have a black mark on your credit, which would make it even much harder for you to borrow money way into the future.
Either way you look at it, all the home values we had a few short years ago have evaporated. If you can keep up with your mortgage, I wouldn’t recommend walking away from your home right now. You’re simply going to destroy your credit by doing so, and I doubt that’s what you want to do.
Why don’t you just sell your house for whatever it takes? You save your credit, take the loss (as you would if you foreclose anyway) and move on. Why foreclose?
Silcon Valley,
Duely noted and true but you have to see that your loses can be recouped in half the amount of time or more. Along with seeing how many people that are foreclosing now, FICO scores could be weighed on a bell curve. And if I wanted to get another house I would have a considerable down payment to use for it next time. Just trying to weigh my options and see if there are other alternatives.
I just feel like the good people who has done everything right will end up getting screwed in the end by not getting relief on thier homes like the others who put us in this situation in the first place and went into one of thier biggest investments of their lives not prepared and really couldn’t afford property. It just doesn’t feel right to me. I want to start the debate. what are your Feelings and/or thoughts? Am I wrong or short sighted about my thoughts here?
I think that the comments suggesting that foreclosure can be avoided by simply managing your money better is short-sighted and ignorant. I bought a house in a gentrifying area of Michigan for 89k-this was cheap even by 2002 Michigan standards-basically, it was a good investment. I put about 30k into it over the course of 6 years and thought everything was going swimmingly…then the market took a dump. My husband is in construction management, he got laid off, there was no work in sight, we moved to Chicago thinking our options would improve and that we would be able to sell our house for a mere 110k. My husband never did find work and so went back to school. Part of the house in Michigan was always a rental and for the first year after we moved, we had a couple of girls living in our portion of the house. Now because no one can sell their homes, there are tons of houses for rent and we just can’t compete. We can’t find renters and can’t sell it and are even trying to sell it for a 10k loss. No dice. I am very good with my money, we used to have a decent retirement account going and for being in my mid-20s, have stellar credit…for now. Between the mortgage, home equity loan and $400 a month in utilities for the entire house, I can’t make the payments without tenants. But oh…this is my fault for not being responsible with money.
While I understand that some people have been irresponsible, there are also plenty of honest, hardworking people who have just gotten screwed through no fault of their own. Open your eyes. People around me are getting laid off left and right and I’m just thankful I still have a job. Foreclosure might be my only options if I don’t find tenants soon and it’s not because I’ve been mismanaging my money.
I am in a similar situation. The house is in my wifes name and financed only in her name. If we walk away, only she takes the hit. Right? I can go out and qualify or pay cash for a new house and wait out the market. Any comments?
Ken,
I dont know what state you are in but in California (according to my real estate lawyer) yes your credit will stay in tact and basically the new house will have to be in your name instead of hers. Good luck and I hope this helps.
To the rest,
I would go back to your lender and request a copy of the title because there were alot of shady things that have gone on durring this fall of the economy where our loans were being sold to two different banks and the original was shredded (hello Enron again). If they can not obtain the title, who’s house is it then? I am anxious to see how that pans out here…
Doug.
My fiance and I are considering foreclosure for her townhouse. I have a house and she has a townhouse. We’ve decided to move into my house because owning her townhouse is not feasible for us and our growing family. She owes 130,000 on her townhouse but others in her development are going for $44,000 – 79,000 with the most recent selling at 65,000. We tried renting it out and had renters until their lease expired 2 months ago. Her mortgage is $1100 and we were only able to get 999 for rent. We are now down to 900 and still haven’t been able to find renters. Why shouldn’t we consider foreclosure. We aren’t going to get the equity back for over 10 years (possibly longer). At what point do we say forget it, it’s not worth it? Any one have any recommendations?
Darin,
If your gut, intuition and peace of mind calls for it, then foreclose. The losses may be too big to recoup after some point and I may just go the route of foreclosure if I end up facing your kind of situation.
I am in a similar situation to Doug. I lost my job in AL 5 years ago. Afterwards I was unable to find a job locally with a comparable salary so I relocated my family to Michigan. Being that I have kids & that my wife & I have lived in AL all our lives I made a promise to my wife that we would stay no more than 5 years in MI. While I have loved living in MI it has now been 5 years & is time to return home. I put over $20,000 down & now have about $50,000 in equity. We bought the 30 years old home for over $300,000 in what was considered by Money magazine one of the top 100 US cities to live in thinking it would be something we could easily get out of in 5 years. Recently I spoke with my realtor who informed me I would be doing good to sell it for what I owe the bank. I have never missed a payment but at this point do not see any incentive to wait until the housing market rebounds in the next 2, 5, 10 years or so. Even if we did stay indefinately just to get our money back out of our house there is no guarantee it will ever get back to where it was. So here I am someone who never missed or had a late payment during 11 years of marriage considering walking away. I do not wish to foreclose or do a short sale as my credit score currently is in mid to upper 700’s. I have read about deed in lieu of foreclosure to get the lender to release me from debt however I don’t think they would even consider giving my current situation. If I walk away I could stay at a family house & save $2000/mth. In 2 years I would have back the $50,000 lost in my house or I could continue putting money in a house in a state I don’t want to be in anymore. Plus being that I work for a auto supplier in a state whose economy seems doomed due to all the auto bankruptcies it doesn’t seem to wise to stay put. Is there any option for me or do I have to break my promise & stay in Michigan for who knows how long?
I am in a similar situation as Ken. My husband bought a house in April of 2007, right before the bubble burst here. According to comps in our area, we are probably backwards about 30-35%. The banks will not work with us, so we will likely foreclose.
I can afford a house with my own income and credit that is actually nicer than the one we are currently in for a lesser payment. We can also save a very sizeable down payment during the foreclosure process. My husbands credit will be damaged but the way we see it, the pros outweigh the cons.
Seems with the amount of foreclosures happening these days FICO will consider foreclosure to be a slightly smaller black mark than in times of economic boom. My guess, anyway.
I lost my job last April. The next day I called Wells Fargo for help. I told them at best I could easily pay my mortgage for 3 more months. They said because we were in good standing with a 10 plus year relationship with them, that we would go to the top of the list. They spent 4.5 months working out remodification only to come back and tell us that we did not qualify for that and would have to refinance. Now we are trying that but guess what? Our income to debt ratio is now 6% higher, you would think this is a given since we lost one income and are applying for help.
This week we learned we have to layout $7,000 in refinancing fees and pay a year’s worth of homeowner’s insurance up front before the refinancing can go through. So here we are, six months later and no resolution yet. So much for the government sponsored program…guess what? After owning a home in Texas for 10 years, selling it, moving here and owning this house for 3 years, we are WALKING AWAY! Everyone wants to talk about the options but no one reports on how those options are so convoluted, being defrauded or withheld for several months in secret hopes by the lender that you’ll get another job and be able to make your payments as usual. What a farce this whole process is.
My husband and I have been dealing with Wells Fargo since February 2009 because our note increased $600.00/month in 6months because of a miscalculation on their part for our escrow. We have been denied for the modification because we were not late on our payments and did not qualify for refinance because we have PMI.
So we contacted Wells Fargo again in August and they said that the rules had changed and we could refinance under the Home Affordability Refinance Plus but they would require an appraisal. Our appraisal came back $100,000.00 less that our original appraisal two years ago so we were obviously denied to refinance.
We have exhausted all efforts to do the right thing and quite frankly are tired of playing with Wells Fargo so we have decided to foreclose. To those of you who recommend not foreclosing because of credit score drop, well our good credit and up to date payment history doesn’t seem to be helping us much. Also we are in a unique situation because my husband is the only one on the mortgage and we have a rental house that we plan to move into.
Good luck to all!