Time To Stop Throwing Good Money After Bad

It was just last summer that Charlotte Perkins made the hardest decision of her life as she and her husband Jim were caught in the vise of the housing bust.

Wanting to downsize their lives as they headed toward retirement, they bought a new house in Mesa, Arizona, before they sold the old one, also in Mesa. Their previous home had been appraised at nearly $400,000 at the height of the market, but as the housing crisis ravaged Arizona, they were told they’d be lucky to get $200,000 for it.

They were carrying a loan of $260,000 on their original home alone, meaning they were well ‘underwater,’ owing much more than it was worth. Combined with the mortgage on the new house, their housing payments had become an “anchor around our necks,” she says, threatening to gobble up all their retirement savings and leave them with nothing.

The couple made a difficult call: They would do a ‘strategic default,’ and simply stop paying the old mortgage. “We really had to wrestle with it,” said Perkins, 60. “We had worked all of our lives to build good strong credit, and we’re proud people. But it came down to, ‘Can we keep doing this?’ We had to say ‘No.'”

Full story here.

The article explored the issue of whether it makes sense to keep paying a massive mortgage knowing that it might be decades before a home regains its prior value.

People naturally feel embarrassed about breaking a contract and not paying their bills; no one wants to be branded a deadbeat. But the article argues that it is not a personal, but a business decision.  Companies default on their obligations through the bankruptcy process when it makes financial sense for them to do so.  Ironically, even the Mortgage Bankers Association itself arranged for a short sale of its Washington headquarters.

The consequence is that your credit record gets blown up in the near-term.  Credit-scoring firm FICO estimates that someone with a 680 score would see that number drop between 85-100 points to 580-595, and someone with 780 could tumble 140-160 points to 620-640.  You will likely not qualify for a mortgage or a car loan for a few years.  When lenders are ready to take a chance on you again, you’ll have to pay a higher  interest rates due to your default history.

Of course strategic default is not a decision to be taken lightly.  It should be a last resort, not a first option.  Since 30-year mortgage rates are at near record lows, you should look into refinancing, loan modification or short sale.

Each state has its own rules and regulations regarding foreclosures, which affect both the length of the process and what you could be liable for in the end.  In ‘non-recourse’ states like Arizona, California and Texas, a lender cannot come after you for any deficiency (the difference between what you owe and how much your property sells for).  The more reason a California homeowner should look into all the above-mentioned options.  In other states they can pursue the difference, in theory – which is why some homeowners opt to file for bankruptcy, to free themselves from those potential obligations as well.  (The hit on your credit score for filing bankruptcy is 130-240 points.)

You should also know the tax implications. Historically, if you have a debt that’s forgiven, the canceled amount is considered taxable by the IRS.  In the wake of the housing crisis, the Mortgage Forgiveness Debt Relief Act was drafted to spare you those taxes. That legislation expires at the end of 2012, and if not extended, you could potentially face a tax bill for the difference.

So talk to a professional. A bankruptcy or real-estate attorney can help you through this very tricky process. The National Association of Consumer Bankruptcy Attorneys, for instance, has a searchable database of lawyers at http://www.nacba.org.

I am an Accredited Distress Property Specialist, licensed in California, and can help you with your short sale.

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About lilynyland

Former Realtor at Coldwell Banker George Realty in Alhambra, California. Graduate Realtor Institute (GRI), Accredited Distress Property Specialist (ADPS), Short Sale & Foreclosure Resource (SFR).
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