I hope this post doesn’t apply to you. That is, I hope you’re not in—or at risk of—foreclosure.
We all know there are still a lot of foreclosures out there. As a Realtor, it’s especially obvious. Every time I drive to one of my short sale listings it seems like there are two new foreclosures on the same block.
What gives? Although you might think that the real estate market—and, in turn, the foreclosure rate—might be improving by now, there are lots of factors preventing that from happning.
One of them is that a lot of people are simply tired of holding onto homes with negative equity.
Nearly 23 percent of Americans owe more money on their mortgages than their homes are worth, according to CoreLogic. Furthermore, an extra 2.4 million homeowners have less than 5 percent equity in their homes.
So many homeowners are paying money for a home that will not increase in value any time soon. And that’s raised an interesting question for many:
If your home is so far underwater that you can never sell it for what you owe, why should you keep paying the mortgage? Why not just walk away? Or at least stop paying until the bank kicks you out?
Although you may be among many who feel it’s unethical to walk away from a debt obligation, others feel walking away is strictly business.
Whether you see it as more of a moral or economic decision, it’s a decision that has some serious consequences to consider. If you’re thinking of walking away from your mortgage or know somebody who is, these are the consequences:
Cancellation of Indebtedness Income
When you sign a mortgage note you are promising to pay off that debt. If you walk away from your home and your debt obligation, the IRS sees the money you should have paid on that debt as a form of income, which you can be taxed on.
Although the IRS does have a provision for allowing some debt to be forgiven if the debt was your primary residency and was purchased between 2007 and 2012, those who bought before 2007 or are walking away from a rental property, vacation home, or business may owe the IRS a hefty sum. (Let’s say you walk away from a $300,000 mortgage balance. If you face a 25% tax rate, you could owe Uncle Sam $75,000. And tax debts do not go away, even in bankruptcy.
Ask your tax advisor about the consequences before making the decision to walk away. This IRS calculator may also help you calculate what you would owe.
Most people know that foreclosure is not good for your credit. But just how much does walking away from your home hurt that credit score, and for how long?
“The Fair Credit Reporting Act requires that negative information must be removed from your credit report after seven years,” says Steve Bucci of BankRate.com. A foreclosure will appear on your credit report (the one pulled every time you apply for a place to rent or a car loan) for up to seven years. Most people have no clue what their life will be like seven years down the road, so it’s hard to know exactly how much walking away from your mortgage today will impact your life tomorrow.
Some employers, especially government agencies, are also pulling credit before hiring, which can make rebuilding your finances even tougher. The way these employers see it is that if you have poor credit, you’re more likely to take a bribe or do something shady to get money. So you should probably plan on renting (from a landlord who doesn’t care about your credit score) for at least five years after walking away, as you won’t qualify for another home loan anytime soon.
An Impact on Others
When your home is underwater and perhaps you’ve lost your job, it’s easy to feel like a victim and that you simply need to look out for yourself. But walking away from your mortgage affects other people, property values and even entire communities. When the bank takes back a property, it eventually relists it for sale as a foreclosure. According to CNN, foreclosed homes tend to sell for about 26 percent less than regular sales.
These foreclosures become comparables for short sales and even traditional real estate sales, driving all holme prices down and making it harder for people to sell their home without taking a loss. Because foreclosed properties are vacant, they tend to be an eyesore for the communities. One house with broken windows and overgrown weeds sticks out among well-maintained houses bringing the values of the other houses down. Empty houses can also be a magnet for graffiti and squatters. Obviously, if your back’s against a wall, this probably won’t stop you from walking away. But when people make the argument that its immoral to walk away from your debt, it’s not just because of the contract between borrower and bank, it’s the unwritten contract between borrower and neighbors.
If you’re deciding to walk away from a rental property, it’s easier to think of it as a business decision. It’s not so easy to walk away from you own home. If you’ve raised a family there, or simply sunk money and weekends into renovations over many y ears, you may focus on past experiences and expenditures rather than how you can improve your future by finding somewhere else to live.
If you’re doing “the right thing” and paying an underwater mortgage or living in a small condo well within your means, it’s easy to judge someone who’s stopped paying their mortgage and maybe even still living in their home scott free.
Even though some non-payers are able to live in their homes anyway, sometimes for years, eventually they will have to leave, and that will not be easy. I would not be surprised if many have continuing feelings of guilt and fear about future consequences.
You may have thought about walking away from your house. If so, take time to weigh the advantages versus these impacts, and consider the other options like staying in your home and continuing to make the payments, renting the home out or doing a short sale.
Have you or somebody you know walked away or considered walking away from a mortgage? Let us know in a comment.
Note: We know this is a controversial issue. Disagreement is OK. Insults are not. Please do not flame others for sharing their experiences or opinions on this. –Ed.
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