Walk away from your home? Not so fast
Consider these important points and focus on the long term.
Recently a reader e-mailed me asking whether he should walk away from his mortgage. In 2007, he bought a condo with no money down with a five-year adjustable-rate mortgage, and the property is now worth $25,000 less than he owes. Although he can afford the mortgage, he is considering walking away. The question is whether he should.
I think there is no "answer" to this question, just things to consider in making the best choice for your situation. We'll talk about some things to consider, but first a brief story.
My wife and I bought our first home in 1993 for $190,000.
Almost immediately after we closed on the home, housing prices started to go down. Because we didn't have nifty home valuation Web sites to consult back in 1993 (my, how times have changed), I don't know the precise decline in the price. But I'd guess it went down 10% in value, or about $20,000.
We stayed in the home; a voluntary foreclosure never even crossed my mind. Prices were depressed for several years. In fact, we probably didn't break even until about 1996 or 1997. Fast forward to 2004, and we sold the home for $435,000 (we live outside of Washington, D.C., where housing prices are insane).
The point is that in the short term, housing prices can do some crazy things. But give real estate enough time, and it generally rises with inflation. Your house may be worth less than you owe today, but when you are making a decision as important as whether to stay in your home, consider the long term.
With that, here are some factors to think about if you are considering walking away from your mortgage.
Your sense of right and wrong. Is walking away from a debt you are able to pay morally wrong? It's one thing if the loss of a job, medical bills, or some other financial crisis prevents you from paying the mortgage. It's another if you can pay it, but decide not to because you've concluded you entered into a bad deal. With that said, I'm not here to pass judgment, but I do think it's a question worth asking if you are thinking about walking away from a mortgage. If you have an opinion on this point, share your thoughts in the comments below.
How underwater is your mortgage? Real estate that has lost significant value generally is located where prices are subject to extreme variation. This would include locations on both coasts, as well as places like Las Vegas.
It also includes locations where employment is highly dependent on one industry. In the 1970s that included Houston. A friend who lived there at the time recalls entire housing developments that were brand new and totally empty. Houston has long since recovered, and real estate prices have risen. Today, Detroit is suffering a similar fate. I suspect it will turn around, but there are no guarantees.
The point is that in those markets where prices have fallen precipitously, they can and likely will rise again by equal or greater amounts. This goes back to my story above -- think long term.
Understand deficiency judgments. Just because you walk away from a mortgage does not mean that you’re off the hook. There are two types of home loans -- recourse and non-recourse. Recourse loans mean that the mortgage company can come after you if they foreclose on your home and sell it but the sale does not generate sufficient income to pay off the loan. Whether your loan is recourse or not depends largely on state law. The key here is to find out before you make a decision.
Explore other options
Depending on your specific situation, there are many alternatives to walking away from a mortgage. Here are a few of them:
- Refinance your mortgage. While your home may be worth less than you owe, refinancing may still be an option under certain federal programs implemented this year. Interest rates remain at historic lows and lowering your rate may give you just enough incentive to stay in the home. If your monthly payment is the big problem, it's worth at least looking into refinancing. You can talk to your current bank or get several free refinancing quotes online.
- Rent out your home. There are two options here. One is to simply rent out your home. The problem here for many will be that rent payments won't cover your mortgage. That's the case with the reader who e-mailed me. Of course, you can always chose to rent it out for less than the mortgage, and simply pay the difference. Depending on how big the difference is, though, renting may not be any better of an option than just staying put. The second option is to offer your home to a renter on a lease-option contract. A lease option is basically renting with an option to buy added to the deal.
- Deed in lieu of foreclosure. With a deed in lieu of foreclosure, you basically get your mortgage company to agree to take ownership of your home in full satisfaction of the outstanding loan. This can be an important option in states where deficiency judgments are available.
- Short sale. A short sale is a sale of your home for less than you owe the bank, coupled with an agreement from the bank to forgive the difference. One of the advantages of a short sale is that you'll be able to buy another home much faster than if you simply walk away from the mortgage.
- Talk to your bank. Finally, talk to your bank about options. If your plan is to walk away from the mortgage anyway, discussing options with your bank can't hurt.
Recognize that your credit score will take a big hit. A foreclosure will have a major impact on your credit score. According to Fannie Mae, a foreclosure can stay on your credit report for up to seven years. A foreclosure can bring down your credit score by 100 to 200 points, making it difficult to qualify for traditional credit. And if you do get credit, it will be at much higher interest rates.
Don't plan on buying another home for several years.
Plan on waiting at least three to five years to buy another home if you walk away. The time is shorter for a deed in lieu of foreclosure or short sale. But walk out on your mortgage and you're looking at a five-year wait.
Will you be better off in the long term? With all of the above factors in mind, consider whether you will be better off five to 10 years later. While walking away from a mortgage might have some short-term appeal, in the long run it could very well make matters worse. Real estate prices have fallen, which can be disheartening. But the real estate market will recover, and prices will rise again.
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