Notes From The Ground Up
Every week, I have at least one client or family come into my office and ask me whether or not they can or should walk away from their home. The scenarios are heartbreakingly similar: really good and honest people who bought their homes at the wrong time (or who refinanced when their home was worth a lot) and now cannot afford to keep up the payments. Yet my advice to my clients is hardly ever the same and depends on their specific situation and objectives. The purpose of this blog is not to provide legal advice, but to merely discuss some of the factors that should be considered in making the decision.
The most common question I get is “Is the bank going to come after us if we stop paying and walk away from our house?” In most situations, the answer is “No”, but there are a number of important caveats.
The first depends on the manner in which the Bank (or more specifically the first mortgage holder) chooses to foreclose on your house. If they proceed in the way that they most often do, through a non-judicial foreclosure (outside of court), then the answer is “No”, the Bank cannot come after the owners for any deficiency (even if the house sells for one half of what is owed). Now, in the extremely rare situation that the Bank chooses to proceed in court by filing a lawsuit, then the Bank can ask the judge for permission to sell the house and then come after the owners for any deficiency. I should stress that it is extremely rare for banks to go through the court process.
The second important caveat to keep in mind is how many mortgages are on the house, or if there is asecured line of credit on the property. Simply put, the non-judicial foreclosure discussed above prohibits the party who is foreclosing (which in almost cases is the first mortgager) from coming after the borrowers for any deficiencies, but it does not block the second or third mortgagors from doing so. So one important factor to consider is whether there is a second or a third mortgage, because those lenders can in theory come after the borrowers even after foreclosure.
But here is where the law ends, and the analysis of each individual situation begins. Just because the Second Mortgagor can come after someone, it does not mean that the bank will. Often times, the banks will not bother pursuing people who have lost their house already. And even if the bank does, it generally ends up settling for a fraction of what the borrower owes. This is especially true for borrowers with modest incomes and no other significant assets.
The bigger point here however is that when considering whether or not to walk away from the house, one should be careful about how to think of the second or third mortgages in determining how underwater the property is. (We will refer to these mortgages as “Second Mortgages”). This is so because the Second Mortgages are not usually in a position to foreclose on a property. Because if they do, they have to pay for the sale costs and pay off the first mortgagor (and any other mortgage that came before their own) before they get paid anything. For this reason, whenever a property is underwater the Second Mortgagors are often willing to settle for a significant reduction on the account so long as payment is made in lump sum. On so many occasions, I had clients come in to my office thinking that they absolutely had to give up their house, only to find out that they may actually have equity in their property if they are able to settle their Second Mortgages. In a typical situation where the house is underwater, the banks generally have been willing to accept anywhere from 15% to 60% of the amount owed. The wide variation mainly depends on the client’s overall financial situation. The worse your financial situation is, the less they will accept.
Keeping all of the above in mind, here are some other factors to consider when contemplating whether or not to walk away from one’s home. The first factor is the debt to value ratio. The more that your house is underwater, the less it makes sense for you to stay. Although the logic here may seem obvious, a very frequent problem that I encounter involves clients who are really underwater but are afraid to stop payments so that it “doesn’t ruin their credit.” It is puzzling when my clients tell me this because they seem to be missing the bigger point. In my opinion, having good credit should be thought of as one of many tools towards financial well-being, not an end within itself. It simply does not make sense to keep a 30 or a 15 year mortgage on a seriously underwater house, just to protect one’s credit. So long as one is set on a solid financial path, the credit standing will inevitably improve with time.
The second factor to consider is how much it will cost to rent another house or apartment. Sometimes, given the family’s unique situation, renting an apartment or another house will cost just as much or more than the mortgage of the existing home. And given the tax benefits, it would sometimes make little sense to walk away from the home, even if the house is worth less than what is owed on it.
The third aspect that I encourage my clients to consider is their overall financial situation and their prospective future earnings. This is a bit complicated for the purposes of this article but if I have clients with significant credit card debt, uncertain income prospects, and underwater assets; I tend to discuss the option of bankruptcy with them (especially if they have a second or a third mortgage on their house). However, we make sure to consider all other options before reaching this decision. In many of these situations the bankruptcy frees the client from having to worry about the mortgages and their personal debt. Yet even for clients with little personal and credit card debt, the smart decision may just be to walk away.
I hate to sound like a heartless advisor, but one of the last factors that should be considered is how much you love the house. Sorry, but in today’s economy and today’s world, most of us cannot afford to think on that level. Instead, we have to think about what is the best rational and economical decision you can do for yourself and for your family.
People who are considering walking away are strongly encouraged to consult an attorney to ensure that the potential move benefits their overall financial situation and objectives.