Should you walk away from your mortgage?
That’s a question millions of Americans should be asking if the home they bought during the housing bubble is now worth far less. Moody’s Economy.com estimates that ~17 million homes are “underwater.”
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There are many factors to weigh, especially mortgage and payment modifications, but draining cash with big monthly payments for a home value that might never return can be a big waste, especially if there are less expensive rentals in the area.
But even when “strategic default” makes economic sense, many homeowners don’t out of fear and guilt.
“A large number of Americans who are underwater on their mortgages would be better off financially if they walked away from their homes,” says Brent White, a University of Arizona real estate expert. “They don’t because we have a double standard…individuals are told they have a moral obligation to pay their mortgages and corporations understand that contracts are to be breached when it’s not economically efficient.”
Not everyone agrees. “I’ve worked with a lot of homeowners and so I understand that perspective. But big picture…the whole idea that people are thinking it’s a viable alternative is very bothering,” says Shari Olefson, a real estate foreclosure attorney with Fowler White Boggs and author of Foreclosure Nation: Mortgaging the American Dream. “It all goes back to the issue of moral hazard.”
Whichever side you take, it’s good to know the default process and other available options.
The idea of 'strategic default' -- walking away from your mortgage -- begins with a basic calculation: is the amount you owe on your mortgage more than the amount your house is worth?
To figure out what your home is worth now -- an inherently imprecise exercise -- the size, condition and location of the house are all important. You can try and estimate it yourself using specifications from the old mortgage (e.g., this list from eHow) and recent sales in the area with zillow.com, called a 'Zestimate.'. Real estate companies like Coldwell Banker also have online evaluator tools or will send an agent to your house for an in-person appraisal.
If the new amount is less than what you agreed to pay, you're 'under water.' That means renting a comparable home makes economic sense if the monthly rental payment is less than the current mortgage. Check your area listings.
But before you walk away, make sure you're on sound legal footing.
The legality and risk of walking away from your mortgage varies by state and should be the first thing you consider.
A minority of states, like California and North Carolina, are 'no-recourse' states, meaning lenders can't attempt to claw-back the amount a person still owes on the mortgage from other assets, like a car or bank account.
Defaults are lower in states that have recourse, like Florida and New York, because, as the New York Times notes, lenders threaten the borrowers with judgments against their assets.
But actual lawsuits are rare because they're costly for lenders, according to USA Today, so there's still a chance to walk away without paying more or losing your car, for example.
The main downside to foreclosure is bad credit.
Buying a home or car is probably out of the question for a few years, but it's possible to have a good credit rating (above 660) within two years after a foreclosure, according to a recent paper by Brent White, a University of Arizona real estate expert. You might even be able to qualify for a federally-insured FHA loan to purchase another home in as little as three years.
Lenders, of course, don't want this. Fannie Mae, the mortgage giant, issues this warning: 'Walking away from your property is not a good choice. Continue to live in your house as long as you are trying to get help from your mortgage company or through a housing counselor. If you abandon your property, you may not qualify for assistance and your credit will suffer.'
Technically, the bad credit could last as long as seven years.
Besides the law, you may also want to consider the moral repercussions of backing out on your debts.
Just kidding! Everyone is doing it. Feel free to ignore this question.
White at University of Arizona runs them down other things to consider here:
- Reasonable estimate of the current value of one's home
- Cost to rent a similar home
- Idea of how long one intends to stay in the home
- Estimate of the average appreciation or depreciation one's home is likely to experience over that period of time
Finally, remember the potential social cost of strategic default. Even if it makes sound economic sense, some still view walking away as a dereliction of duty or somehow irresponsible to the neighbourhood (in terms of hurting other property values).
If you've weighed all the risks -- legal, moral, and otherwise -- and want to walk away, all you need to do is this: absolutely nothing.
As a courtesy, some people send banks their keys (called 'jingle mail' in the industry) but technically, defaulting on a mortgage means just that -- not paying it.
Lenders, of course, will assume you're just late on your payment so expect letters in the mail and plenty of phone calls from collectors, much like being late on credit card bills.
And even if you tell them you're walking away, they'll try and change your mind with refinancing or low monthly payments, options you should have already considered.
Lenders usually take things seriously after three months of non payment, again assuming you're just late.
According to a review of the process from How Stuff Works, most lenders will begin the foreclosure process in one of two ways after three months of missed checks: judicial sale, which requires that the process go through the court system, or power of sale, which can be carried out entirely by the mortgage holder.
As the article notes, all states allow judicial sale, while only 29 allow power of sale: 'If your state allows power of sale, the loan papers will usually have a clause that says this method will be used. Power of sale is typically faster than the judicial route.'
Here's how a judicial sale works, according to How Stuff Works:
- The mortgage lender will file suit with the court system.
- You'll receive a letter from the court demanding payment.
- Typically, you'll have 30 days to respond with payment to avoid foreclosure.
- At the end of the payment period, a judgment will be entered and the lender can request sale of the property by auction.
- The auction is carried out by the sheriff's office, usually several months after the judgment.
- Once the property is sold, you're served with an eviction notice by the sheriff's office, and you must vacate your former home immediately.
Here's the process for a power of sale foreclosure, again according to How Stuff Works:
- The mortgage lender will serve you with papers demanding payment.
- After an established waiting period, a deed of trust is drawn up that temporarily conveys the property to a trustee.
- The trustee will sell the house at public auction for the lender.
- Many times, these foreclosures are subject to judicial review to make sure everything was carried out legally.
- There is usually a requirement for the lender to post a public notice of sale for the auction.
Assuming you go through with strategic default and it's in sound legal standing, all that's left to do is find a rental property that's less expensive than the unwieldy mortgage payments that pushed you out in the first place.
Remember though, your credit isn't what it used to be, and your spending will likely need to be more conservative for a few years.
Walking away isn't the only option.
If you want to stay in your house but may have trouble making mortgage payments, lenders and the government have a variety of programs to help as part of addressing the housing crisis. The process can be long, painful and the modified term offers often don't meet expectations, especially if you're current on your payments. But it's something.
The federal Making Home Affordable Program has two main options -- mortgage refinance or lowering monthly payments. Fannie Mae summarizes:
Home Affordable Refinance: 'Many homeowners pay their mortgages on time but are not able to refinance to take advantage of today's lower mortgage rates, perhaps due to a decrease in the value of their home. The Home Affordable Refinance may help borrowers, whose loans are held by Fannie Mae or Freddie Mac, refinance into a more affordable mortgage.'
Home Affordable Modification: 'Many homeowners are struggling to make their monthly mortgage payments either because their interest rate has increased or they have less income. The Home Affordable Modification may provide them with mortgage payments they can afford.' Other major lenders are participating in the program, although with limited success.
According to Fannie Mae, there's also:
Forbearance: 'your mortgage company may let you pay a portion of your regular payment or no payment at all for a specific period. At the end of the forbearance period, you begin making regular payments as well as an additional amount to pay off the past-due amount.'
Repayment plans: 'you may be able to catch up on missed payments by creating a schedule for repaying the past-due amount.'
HomeSaver Advance: 'if your missed payments are due to a temporary financial hardship, you may be eligible for an unsecured personal loan to help you get current with your payments.'
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