Some friends of mine found, about a year ago, that they just couldn’t afford their mortgage any longer. Their ultimate decision was to simply stop paying and let the bank foreclose, although they decided not to tell the bank this, as they wanted to put it off for as long as possible.
They’re now living in a new place, and still haven’t told the bank. They’re well-aware that their credit is going to drop through the floor when the foreclosure finally happens, but they haven’t mentioned any other financial repercussions beyond that.
I’m wondering- is that it? A credit hit? Will the bank have other options to try to recoup the money? Essentially, what I’m concerned about is, six months down the line from now (or whenever) my friends getting hit with some ginormous bill they’ll be unable to pay / deal with.
It is my understanding that they just take your house, you get a credit hit for a few years and that is it. Taking the house was the threat written into the contract and that is the full extent of the financial penalty. The mortgage companies just never expected many people to volunteer to let them do that because housing prices were not supposed to fall much according to once common wisdom.
Walking away from house that has a mortgage much larger than it is worth is a smart financial decision for some people as long as they have another place to live.
Not quite the same, but I will relate a story for other situations.
Daughter and ex-husband were underwater, with a second mortgage. They did a short sale, but neglected to clear up the second at the same time. Several realtors have since told me that a typical second gets settled in a short sale for $1000 or less (even fairly large ones).
The bank that held the second was like a pit bull trying to collect from them. After two years and two moves, they started calling my number (daughter was living here) and said they were going to sue. They would not settle for anything close to $1000
So, if you need to walk away and have a second, be careful.
There are 12 non-recourse states: Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah, and Washington. In those states, once the bank has the house back, it can’t come after you for any further money. In all other states, depending on the local laws the bank may be able to sue you (unlikely if you have no money), or try to garnish your wages or put liens on other assets. They can also sell the loan to a collection agency who can then come after you.
The bank has a fiduciary duty to bid the highest price possible for the house. The amount bid is usually the unpaid balance of the loan. Often there are subordinate liens, and the lienholders have to be given notice so that the sale will be free and clear of those liens. (Some are legally superior, such as taxes and federal liens.) If the amount bid is less than the unpaid balance, in those states that allow it, a deficiency judgment can be had.
I’d like to see a cite for that. Here in NJ (not on your list) people are walking away from mortgages right and left. No one is contemplating any sanctions other than loss of underwater properties. And these are shrewd real estate people. (Possibly they’re so shrewd that they have some way around the issue, but I don’t think so.)
Also, I heard or saw some media report which said that all mortgages in the US are non-recourse.
Are you privy to the discussions going on in the halls of the lending institutions? It could be that few (or perhaps even no) efforts have been made (so far) to pursue those who default on their mortgages, but it is an option under the law in many states.
Of course, if the person defaulted on their mortgage because they lost their job or otherwise have no money, then pursuing them for the balance might be seen as a rather pointless exercise. Also, i believe that, even if the lending institution does get a judgment against the borrower, such debt can be discharged in bankruptcy, just like most other debt. So, if you default on your mortgage and declare bankruptcy, you won’t be on the hook for the difference between what you owed the bank and what your house was worth.
So, even in states where the lender is allowed to go after the borrower, they often don’t pursue the issue because there’s basically no point.
Lenders pursuing defaulting borrowers becomes an issue when the defaults are strategic, and/or when the borrower has other assets that the lender can pursue. During the recent housing crisis, some people who could afford to pay their mortgages decided to default anyway, because their houses had lost so much value that they figured it was financially preferable to default and start over rather than continue to pay a large mortgage on a house that was worth far less than what they paid.
We discussed one such defaulter here. And here is the story. This couple was contemplating walking away from their mortgage, even though they could afford to pay it, because their house had dropped in value since the purchase. Now, they were in California, so they could have done this without the bank going after them for the balance, but in other states the bank could have sold the house and then pursued them for the difference.
This is what some lenders started doing in states like Florida:
That story supports some of what i argued above. for example:
Also, even if you have no money right now, it might be in the bank’s interest to go after you, because, as the article notes, many states allow up to 20 years to collect a deficiency judgment. Plenty of people can get their finances in order during that amount of time, but if they haven’t declared bankruptcy the debt will still be hanging over their heads, inflated by an interest rate of about 8%.
Since California has been mentioned several times, let me clarify the law in California:
Only purchase money loans on a one to four unit owner-occupied building are non-recourse by law (of course, you can negotiate a non-recourse loan on anything else if you find a lender willing to do it). Refinances, home equity loans, “cash out” loans, etc are NOT non-recourse.
But there is another twist in California, the “one-action” rule. Although a lender can file both, a lender can only complete a judicial or non-judicial foreclosure, not both. If the lender completes the non-judicial foreclosure (“trustee’s sale”), the lender may not then go to court to attempt to get a deficiency judgment against the borrower.
Because of the expense and delay involved in a judicial foreclosure, most lenders choose to go the non-judicial route unless the prospects for recovering against the borrower make it seem worthwhile.
Mortgages have built into them specific conditions about the consequences of failing to make your payments. Those consequences are, as we’ve been discussing in this thread, limited in some states by specific state laws.
In most cases, the mortgage provides that if you fail to maintain the schedule of payments set forth in the contract, you forfeit the house to the bank. Failing to pay your mortgage is not theft. If you stop paying, you suffer the exact consequences laid out in the contract that you signed. The penalty you pay is that you lose the house.
If the value of the house is less than what you owe on the loan, many states allow lenders to go after you for the difference. Some states do not.
Whatever you might think of strategic defaulters, they are not thieves.
Right, and this is also the case on other types of forgiven debt. If you can get your credit card company to forgive $10,000 of the $20,000 you owe them, that means that you’ve effectively been given $10,000 by the company, and the IRS is going to consider that income.
Quite right. When you take out a mortgage, surely you are agreeing either (a) to reply the moneys owed, or (b) give up your house to the bank. If route (b) makes more financial sense, then surely that is your prerogative? The bank is charging interest; the flipside of that is that it must bear the risk that the house may fall in value and it will lose out on the deal.
There are very few credits/deductions for spending. Housing, eduction, etc., sure. But there is no interest deduction for buying, say, a rare title page.
If you bought one on credit–and the creditor foregoes collecting that debt–you have the title page and the assets you would have used to buy it if it were not for the credit. The IRS is basically treating that as a type of income.