As the turn down is housing drags on, many homeowners are now underwater. Around 3.5 million homeowners are behind in their payments and another 1.5 million homes are already in the foreclosure process, according to RealtyTrac. As banks and Lenders start to work through their backlog of distressed properties, the Federal Reserve estimates that 3.6 million foreclosures will take place during the next couple of years. So, the question is: Does it make sense to keep paying a massive mortgage, knowing that it might be years before a home regains its prior value?
As a Realtor I constantly get calls from people saying, I've exhausted all my life savings, my retirement is gone, and now what can I do?
What Is Right?
There's a moral component to that decision. People feel embarrassed about breaking a contract and not paying their mortgage and no one wants to be labeled a deadbeat. Still in America larger companies default on their obligations when it makes financial sense for them to do so, via the bankruptcy process. Yet it's not really personal; it's business. So think of strategic default as a business decision, and do a cold-eyed cost-benefit analysis of whether it makes sense for your family and you. Many people feel it reflects on their integrity, yet the more business like attitude is to say that there's a contract, there are penalties for violating that contract, and sometimes it just makes financial sense to break it. The penalties largely revolve around your credit record, which admittedly takes a negative nose dive in the near term. For a few years you can likely forget about qualifying for a mortgage. When lenders are ready to take a chance on you again, you'll have to pay for the privilege, with higher interest rates due to the default.
What Happens to Your Credit Score?
Strategic default isn't a decision to be taken lightly. If everyone did it, the housing market and the banks would be in much worse shape than they already are.
The following are some of the issues to keep in mind:
1. Talk to a professional. A bankruptcy or real-estate attorney can help you through a very tricky process. The National Association of Consumer Bankruptcy Attorneys, for instance, has a database of lawyers. Also a good Realtor can provide information about possible options.
2. Look to it as a last resort. Your financial troubles could be alleviated with a simple refinancing, especially since 30-year mortgage rates are near record lows of around 4 percent. If the banks are hesitant to rework your loan, look into the number of government programs designed to keep you in your home. Some states, including our home state of Kentucky, has a great program for helping those who have an income reduction or prolonged unemployment.
3. 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 bust, though, the Mortgage Forgiveness Debt Relief Act was drafted to spare you those taxes. That legislation expires at the end of 2012, if it's not extended, you could potentially face a tax bill for the difference.
4. Use the interim to save. In truth it might be a year or longer before you actually have to pack up. In the meantime, be extremely disciplined about stockpiling cash. That will help you with a down payment for a rental, to pay for a car in cash if you need to, or to clear up other debts you might have.
A strategic default is not an easy decision, and there are costs either way. Yet the question is would you rather be $100,000 underwater on your mortgage or would you rather have several years of damage to your credit report? It depends whether you're at financially and what you see happening in the future.
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