Recent news about housing has been positive, as foreclosures have decreased in comparison to recent years. There are many possible reasons for the reversal of the trend, and many individuals and entities that want to take credit. But this blog will address one of the most difficult questions facing a distressed homeowner in foreclosure – when is keeping your house no longer a sound economic and financial decision? Instead, this will address when you should walk away and what potential consequences should be considered.[1]
Why let it go?
First of all, you should start with the terms of the promissory note/mortgage itself (“mortgage” for later reference). Before struggling for a way to catch up the past due payments and avoid foreclosure, ask yourself if you can afford to make the regular monthly payments in the future. Too often homeowners will suffer a permanent decrease in income which makes their mortgage payment unaffordable, absent a drastic reduction in expenses (such as nonpayment of utilities or cancellation of state law required insurance) and borrow the money to catch up the payments, only to go back into default a few months later. Many times this money will be acquired from qualified retirement vehicles such as IRAs and 401(k) plans. Not only is the house lost later on because of the inability to make the regular mortgage payments, but the homeowners’ retirement plan has been depleted.
The second issue to be considered is the amount of equity -if any – in the house. If the house is “upside-down” – meaning the mortgage indebtedness exceeds the fair market value of the house – then keeping it may not be a sound economic decision. While a house with equity offers the opportunity for a later sale with proceeds available for the homeowner, negative-equity means that the homeowners will be unable to sell the house as the value to be obtained will be less than the amount owed. Consequently, the lender will not agree to the sale.[2] The homeowner should investigate several factors to obtain a fair market value of the home: the tax assessed value; the purchase price if purchased within the previous five years; any recent appraisal obtained for a refinance or other purposes; and comparison sales. Has the property increased in value since the purchase, or decreased? Is the market flooded with many other properties that are for sale? Has there already been a high amount of distressed sales in the area? If a downward trend in value becomes apparent, it may be a good idea to let the property go.
In addition, also consider the fitness of the property for your current needs. If the homeowners have any disabilities, stairs and other variations in structure height may no longer be navigable. Caring for the exterior of the property, such as landscaping or pool maintenance, but not be physically possible or affordable. Or the children may have moved out and downsizing may be appropriate. Think long-term when evaluating the decision to let it go, both from an affordability and fitness standpoint.
What are the consequences?
Relocation is probably going to be the most immediate consideration. Do your homework, and research rental properties in your preferred living area. This is especially important for families with young children, who may not want to move them to a different school. Find out if your lender participates in a “cash for keys” program where they will pay you to voluntarily exit the property within a specified period of time (usually 30-90 days) in exchange for a cash payment.
While a mortgage company has the right to obtain a deficiency claim in the event that the house is sold for less than the mortgage balance, this is not very common in Georgia with respect to a primary residence. Georgia law requires that the lender obtain a confirmation of the sale in the Superior Court of the county in which the property is located. Many lenders choose to forego confirmation of the sale as it can potentially cloud the title of the property and prolong the resale. However, a second mortgage creditor is not required to obtain a sale confirmation, and may pursue the former homeowner for whatever amount of their debt that remains unpaid after foreclosure. Many times a Chapter 7 bankruptcy will be filed after the foreclosure to protect consumers from the collection of a deficiency claim.
Whether the foreclosure sale is confirmed or not, there is always the possibility of the debt being voluntarily cancelled (“forgiven”) by the lender. A lender may forgive the debt so that it can be declared a loss on their books, with the consequent tax benefits. “Forgiving” the debt means that the lender will not hold the former homeowner responsible for the debt. While this would appear to be the ideal outcome, it does present another peril for the consumer. Cancellation of an undisputed debt is treated as income by the Internal Revenue Service. If the lender issues a 1099-C (“Cancellation of Debt Income”) for the amount of the foreclosure deficiency, the consumer could be responsible to pay income taxes on the forgiven debt just as if that amount had been earned. This can result in significant tax liability if a house is substantially upside down, and there is a large deficiency claim after foreclosure. Keep in mind that there is no taxable “event” if the debt is discharged in bankruptcy, so many attorneys will recommend a pre-emptive bankruptcy filing to discharge a potential deficiency claim, and prevent future tax liability.
Conclusion
Facing the loss of your home can be traumatic, but remind yourself that you have to react logically and not emotionally. Evaluate the home’s worth versus the amount of the outstanding debt. Consider your income, and any potential reductions or interruptions going forward. Evaluate your needs in light of the house and the surrounding neighborhood. And finally, consider the potential consequences of letting it go. Whether you want to fight to keep your home, or let it go in light of the above considerations, seeking the advice of a bankruptcy attorney would be very advisable to prevent any mistakes or surprises.