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The Consequences of Walking Away From a Mortgage

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% 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% 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?

That’s exactly what some people have done.

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.

Ruined Credit

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% 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.

Emotional Damage

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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About Sarah Davis

Sarah Davis is a real estate broker in San Diego, Calif. She enjoys helping both buyers and sellers and was voted one of the top 10 best real estate agents in San Diego in 2013 by Union Tribune readers. In her spare time she talks about real estate on a local radio show and manages her website RealtorSD.com.

Comments

  1. I might also add to this article that distressed borrower or those who know they cannot pay their mortgage (imminent default), should ALWAYS call their mortgage company and acquire about a modification before walking away from the home.

    There are many steps a bank can take to make your mortgage affordable including:
    -Bringing the loan current
    -Decreasing the interest rate
    -Extending the term of the loan
    -Forgiving or forbearing principal on the loan

    That being said, some situations will sadly result in the situation you are describing and this article does a great job highlighting considerations borrowers in that situations must make.

  2. Natalie says:

    In the article, you state: ‘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.’

    According to my understanding, the IRS cancellation of debt actually applies to foreclosures and shortsales which occurred between 2007 and 2012, not to homes purchased during that time. This would make sense because 2007 is when the bottom fell out of the market and it is homeowners who purchased prior to that year who are in the worst position, not people who bought later.

    This is important to me because this October Bank of America began sending my parents foreclosure notices in the mail. My parents were current on their mortgage payments, but BoA had decided they were too far underwater on their home to be a safe investment and chose to foreclose anyway. BoA refused to allow my parents to make any more payments, and gave them an auction date. Their calls and letters trying to resolve this were “lost” and, fearing they might come home to changed locks, they moved into a rental. They immediately began working with the bank to short sell the house, and are waiting while the bank reviews offers. This home was purchased in 1996, but will probably be sold at a loss in the summer of 2012. I believe the Mortgage Forgiveness Debt Relief Act was made to help people like my parents.

    • Upside down homes have sadly become a far to common situation in the market today. Working in Chandler, AZ I have seen a ton of people who have had foreclosures over the last few years. I’d like to clarify a few items from the post regarding the mortgage debt relief act.

      The actual purchase date is not relevant when it comes to the IRS. If you purchased a home in 2001 and the home is underwater and you have to walk away this act may help you. I say may because there is one key that wasn’t mentioned previously. The act only relieves debt that was used for primary residence acquisition.

      Ill give you two quick examples

      A taxpayer buys a home in 2000 for 100k. The taxpayer has a interest only loan and the balance in 2012 is still 100k. This home is then foreclosed on because it is only worth 80k. The 20k balance would likely fall under the relief act. Keep in mind there are other rules and you would want to confer with a tax professional like myself with details to be sure.

      Scenario 2
      A tax pay buys a home in 2000 for 100k. On 2007 the taxpayer takes out a 40k home equity loan since the house has gone up in value to build a pool. In 2012 the home is only worth 80k and is foreclosed on.

      100k balance on first loan
      40kon second loan

      Total debt canceled would be 60k however only the 20k for the first loan would be eligible for the relief act. The remaining would be cancelled debt income and the tax payer would have to look into other exclusion options such as insolvency.

      The foreclosure of a home is never a fun thing but unfortunately the market has turned people that never miss a payment on anything into people letting go of homes. It is vital to know what will happen though before making any decisions. Keep in mind with my scenario above 40k in cancelled debt income at 25 percent tax bracket would equate to an additional 10k in taxes due.

      Again I am a tax accountant in the Chandler area and I do work with people throughout the country. Feel free to shoot me an email if you have any questions info@chandleraccountant.com.

      Ryan Stone
      Schneider & Stone PLC
      3125 S Price Road
      Chandler, AZ 85248

      IRS Circular 230 Disclosure: To ensure compliance with requirements imposedby the IRS, we inform you that any U.S. Federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

  3. Something is wrong with this story. The bank can’t foreclose unless there is a default under the mortgage. Being underwater is not a default. A bank can’t foreclose on a home where there homeowners/mortgagors are current. Not to mention that they wouldn’t rationally want to. If the homeowner is paying the mortgage, they are getting their money. If they foreclose and sell the property, they are taking a hit.

  4. Natalie says:

    BG, my parents were behind on their property taxes; I should have included that in my previous comment. They had set up an escrow account with BoA, were making catchup tax payments into that account, and thought they had everything worked out with the bank, but then they received a notice setting the auction date (they had not previously received a notice of default or any indication something was wrong). They had the money to completely pay off the property taxes and continue making mortgage payments, but BoA wouldn’t accept payment because at that point foreclosure proceeding had been started.

    After that, BoA tacked on an additional $25,000 in attorney’s fees which had to be paid if they wanted to resume the mortgage. They were not in a position to pay the additional fees, so they attempted to work it out through forbearance, loan modifications, etc. The short sale is their last resort.

    I’m sorry I didn’t include the details in my first comment. I was just trying to use my parents’ situation to illustrate a case for the IRS cancellation of debt, but I should have presented the whole story.

  5. For those who may be considering walking away, not because they cannot afford the payment, but rather because they are so underwater it does not make financial sense to continue paying it, they should consider that some states now allow banks to go after mortgagees personally, even after foreclosure, for any remaining balance owed on the mortgage.

  6. I had the moral attitude that I should not walk away from debt either. My mom raised us to understand finances from a very young age. I had been married for 13 years and had married my husband with the understanding that we wanted me to be a SAHM. 13 years into the marriage he left and froze our assets. Left me penniless with our 2 daughters. My parents tried to help by getting us a lawyer, I went to court and tried to force a short sale on our joint home that we had just refinanced the previous summer. It took over a year for the courts to decide on our children custody. In the state I lived in, household financial matters cannot be taken care of until this is decided upon. This entire time I was without income other than what I could make doing hair which I had given up doing 13 years prior… My parents had taken me in. I visited the home we had owned and asked neighbors to please keep an eye on it. Explaining to them what was happening. I also came and kept up the yard on my weekends. My ex-husband came and took things that were ours that I would never be able to get back. He left trash and brought women there. He had moved to a neighboring state that he worked in but visited the house as he pleased. Hence the reason my girls and I did not stay after he left us.

    Alas, right after all was finalized with the courts and the house was to be short saled it was already in foreclosure. My ex-husband didn’t care as he had property to move to that his parents had given him to live on. He claimed bankruptcy and magically “lost” his very well paying job shortly after claiming bankruptcy (leaving me with the entirety of our household debt). I was served papers at my place of employment and the support payments of nearly $1900 a month that I had only received for 3 months ceased…. My checking account was garnished, right prior to rent being due on the apartment I had been able to afford for me and my girls. We lost that home the following month. Since then I have been in two different rentals with my girls. We are moving again in July. I do not know where or how…. I was the family that was always able and responsible. I had savings, life insurance, great credit, Roth IRA, 401K, pension and an awesome credit rating. It was gone in the time it took him to walk out the door.

    Don’t be too harsh to judge the motives of those you have not walked in their shoes…

  7. Amen, keep the faith Dawn, many judge when they have not been in your shoes!
    I have!

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