Breaking up (with your mortgage) is hard to do

October 6, 2010

fanoosh

As the housing market continues to take a beating, the number of strategic defaults is rising, triggering a strong reaction among Americans.

The following is an excerpt Psych Yourself Rich: Get the mindset and discipline to build your financial life by Farnoosh Torabi, excerpted with Permission of FT Press, an imprint of Pearson:

Here are some of the factors our experts say are extremely important to consider before deciding to walk away from this specific money relationship. And in any sticky situation like this, you may want to get legal help from a bankruptcy attorney.

Your bank won’t help. The bottom line is, banks don’t want to go through another foreclosure process. It takes time and money. But if playing scared and saying you desperately need to modify your loan or else fails to earn you any material help, consider it a sign you have to take matters into your own hands, which may require walking away.

And before you do, make sure your bank also has no plans to chase you down and sue you for “deficiency” claims, says Gerri Detweiler of Credit.com, which, depending on your situation, could end up costing thousands and thousands of dollars. Some states, such as California and Florida, now prohibit deficiency claims, and in other states some lenders are choosing not to go after defaulted borrowers because they’ve got too much else on their plates. But, “until the statute of limitations is expired, I wouldn’t think I was in the clear,” says Detweiler. croppedcover

“The lenders may come after you in a couple of years after taking a deep breath.” Some attorneys recommend getting a signed letter from your bank stating it won’t sue you for deficiency claims. You’re not able to save or address your other immediate money relationships. Of the 5,000+ members (at the time of this writing) who’ve so far signed on to YouWalkAway.com, many have decided to forgo their mortgage because they say they’re no longer able to save any money. “They see [their home] as a major drain to their savings and cash flow in general. They don’t want to keep bleeding, basically,” says CEO Jon Maddox.

If every payment on your mortgage is a step backward from achieving your other top financial goals, like saving, putting food on the table for your family, and paying down your other debt, a foreclosure, he says, may be a suitable path, especially if you don’t see the area appreciating in value in the next five, seven, or ten years.

You’re okay with damaging your credit. A foreclosure stains your credit report for seven years, much like Chapter 13 bankruptcy, which is a partial debt repayment plan. A Chapter 7 bankruptcy, which eliminates your debt entirely, sits on your credit report for ten years. Despite foreclosures becoming more common, don’t expect any lender to cut you a break.

“Ultimately, lenders make decision based on risk,” says Detweiler. “Lenders really shy away from serious negative items like foreclosure and bankruptcy.” It will take at least a few years before you can qualify for a new loan, and your rates will be extremely high.

To put it in economic terms, “Your credit score is going to limit your opportunities for consumption and your choice matrix,” says Brusuelas. Another tip: Don’t let the potential consequences on your credit report decide between filing for a foreclosure or a bankruptcy.They’re both quite ugly. Instead, examine the bigger picture. Determine what your future goals are and what the best personal strategy may be for you.

And talk to a bankruptcy attorney to weigh all your options. “The homeowner needs to focus on what is the best financial strategy for the next, say, five years, versus trying to beat the credit scoring system,” says Detweiler.

You’re otherwise “okay” with it. This is where your conscience can potentially take the steering wheel. The decision to walk away from your home has been chastised in some press for being “immoral.” A contract is a promise, some critics argue, and therefore should be upheld no matter what. It’s an obligation, plain and simple.

What’s more, foreclosing on your home potentially lowers the value of the neighborhood and hurts the value of your neighbor’s home and the stability of the overall economy. Are you okay with that? University of Arizona law school professor Brent T. White wrote in a controversial paper titled “Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis,” that if it was in their best financial interests, homeowners should consider ditching their mortgage and not worry about the “moral hazard.”

Maddox agrees, telling me there’s no moral obligation to keeping an unfavorable mortgage, considering if all the above holds true. Desperate mortgage holders should do what they can to help themselves get out of a painful situation, especially when their bank won’t compromise or modify the loan.

That means considering all alternatives: renting out a room, selling the house for a loss, and yes, even walking way. After all, he says, banks have no problem breaking contracts or writing off assets. “If banks cut their bottom line by, for example, firing workers, they get applauded by shareholders.

But guys struggling to pay for their kids’ college because their mortgage is too high, those guys get thrown under the bus and we say they’re deadbeats, unethical, and immoral.”

Breaking up is never easy. Before parting ways—whether it’s with a mortgage, a financial advisor, or a particular bank—you need to evaluate the pros and cons, as well as the consequences on your finances and on your stability.

Photos, from top: Author Farnoosh Torabi in an undated handout photo (top) and a screengrab of her new book (left).

2 comments

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I just read your post, the information provided related to mortgage is excellent. It is a nice blog. Thanks a lot for sharing this.

Posted by Terms | Report as abusive

Here is my main issue with walking away. If you walk away from your mortgage then don’t complain later that no one will lend to you or the rates are to “High”. You are a deadbeat (financially speaking). The problem is that our “Gov’t” will say this is unfair, those evil banks will not loan money to these poor people who made a few mistakes 5 years ago. The next thing you know there will be a gov’t program to underwrite the loans to these disadvantaged people and I get to cover the bill when they walk away again. Note: If the choice is between eating and keeping the lights on then I have no issue with bankruptcy. This concerns people who can pay but it no longer fits their lifestyle

Posted by DavidS95 | Report as abusive

[…] we lose our minds,” says Farnoosh Torabi, a personal-finance expert and author of the books Psych Yourself Rich and You’re So Money. “Our dopamine levels skyrocket, and we begin to imagine taking that […]

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