by Broderick Perkins
(05/10/2010) Home owners who are "underwater" with their home loan and seek to come up for air by walking away from the debt, could still be gasping for relief years down the road.
There are occasions when walking away from your home -- and down the road to foreclosure -- is your only option, but seldom, if ever, is it the best alternative.
Mortgages are "underwater" or "upside down" when the property experiences negative equity -- the mortgage is larger than the current value of the property. Negative equity is caused by a decline property value, an increase in mortgage debt or, most likely, both.
First American Core Logic says nationwide more than 11.3 million home owners are underwater with their mortgages.
That's due both to the rapid decline in over-inflated property values during the housing bust, as well as home owners' housing boom habit of tapping their home equity like it was an ATM machine.
"Most likely they got one of those low rate, adjustable, negative amortization, little- or no-money-down loans and bought their home for $600,000," said Rob Roham broker owner of Advisors Real Estate Group in San Jose.
"They probably have a loan of over $500,000 on this property. The value of this home has dropped to under $300,000. Even if the home owner has a good job or business and can afford to pay the monthly mortgage -- which by the way, will continue to go up -- why should they make payments for the next 20 plus years, on a $500,000 loan when the property is worth only $300,000," asks Roham.
Roham continues, "They worked hard to buy a piece of the 'American Dream' a few years ago, with hopes for a nice home to live in and plenty of real estate equity to hopefully retire with some day."
"Now, the market has crashed and not only haven't they made any equity, they have lost what they put in as down payment and are about to lose the home," Roham said.
No one can predict how long it will take for appreciation and property values to return to levels sufficient to eliminate walking away as an option, but experts say equity gains should never be the sole basis for buying a home in the first place.
In good times and bad, buying a home comes with as many as a dozen tax write offs from the interest on the first and second and mortgage and points to a home-based business deduction and a capital gains tax exclusion when you sell.
Unlike rental living, owning a home is a tangible asset, an investment that's also a roof over your head. Within it you can also carve out income-producing space, say, for a home office or to rent out a room or portion.
Some argue, in exchange for the shot at all those hefty perks, courtesy the American Dream, home owners have an obligation to prudently plan to buy only what they can truly afford, invest wisely with a down payment sufficient to create an upfront equity cushion, and to meticulously manage the mortgage so that equity remains in place for emergencies or other sound investments with a decent return.
Even home owners who do all the right things and still get burned are nevertheless obligated by contract to pay up -- or so the argument goes.
Foreclosures constitute a loan default and that can crash a credit report and credit score for up to seven years.
Also, there is a potential that certain jobs tied to checking a consumer's credit report (say, for security clearance) will become elusive. Financial services like insurance can become more expensive. Most credit, especially cheap credit will disappear for the duration of the black mark.
"In addition to the hefty moral issues, there will be hidden punishments that attach themselves to people -- a lower credit score the hidden penalty of higher insurance premiums and perhaps, one's hire-ability for certain jobs that require a security screening," said Mary Pope Handy, a real estate agent with the Sereno Group in Los Altos.
Perhaps only a few years will pass before creditors return with new offers, even if your credit report is still scarred by the foreclosure. However, your credit score will remain low and you'll pay through the nose for any credit you can get.
"Heck, you can buy a home after a bankruptcy after two to three years. If you walk away in a foreclosure, it will be about three years before you can buy again," says Robert Aldana, a real estate agent with Intero Real Estate Services in San Jose.
"Too many people get caught up in the moral dilemma. You need to look out for your family and what best for you and them. Lenders do the same and will take your home if it makes sense to them regardless of how many kids you have," Aldana said.
Aldana has another perspective.
"If you owe $600,000 on a property that is worth $300,000, with an average appreciation rate of 3 percent per year, it would take you 13.25 years just to recoup the loss and break even. That means that for the next 13.25 years, you are paying rent on your home because you are not making any money, you are barely breaking even. And probably not paying a cheap rent either," Aldana says.
Aldana adds, "If the lender gave you a loan mod with a 3.5 percent fixed rate payment for that loan of $600,000, your payment would be approximately $2,694. Add taxes and insurance and your total payment is somewhere around $3,500 which is about $1,500 more than what you would be paying for rent on a similar home. That's an extra $90,000 in 5 years or $180,000 in 10 years of extra payment versus rent. And that's supposed to be OK as long as you get to say that you are a homeowner?"
In addition to consulting with a financial expert about the credit report and credit score implications, a tax expert's advice also may be necessary to understand potential tax implications on both the state and federal levels.
When a lender forecloses on a home and accepts a sale amount less than the loan balance from sale of the home, that can result in a gain in the form of forgiven debt or canceled debt, which is potentially taxable income.
Under federal law, "The Mortgage Forgiveness Debt Relief Act of 2007" generally provides an exclusion for some forgiven debt, including any debt reduced through mortgage restructuring, say a mortgage modification. The exclusion from taxes, however, is only for mortgage debt forgiven from 2007 through 2012 and state income tax laws vary on the subject.
Homeowners considering walking away from their mortgage may also want to consider a real estate attorney for any legal implications or wrangling with the lender during foreclosure.
"Anyone who walks away with a foreclosure on their record will have bigger consequences than having a group of professionals help them get out of it with minimal damage not only to their credit, but to the current and future employment, security clearance and any rights for the deficiency judgments," said George Saghafian a distressed property expert and real estate agent with Intero Real Estate in San Jose.
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