Warning: Walking away will be costly

WASHINGTON – The two largest sources of mortgage money in the country have a blunt warning for anyone thinking about joining the growing “walkaway” trend and becoming one of those homeowners who stops making payments and months later sends the house keys back to the lender: You will feel the pain.

On March 31, Fannie Mae sent out new guidelines to lenders. Fannie now will prohibit foreclosed borrowers from getting another mortgage through the giant investor for five years unless there are “documented extenuating circumstances.” In those cases, the prohibition is three years.

Even after five years, borrowers with foreclosures in their files will be required to make at least a 10% down payment and will need minimum FICO credit scores of 680.

Freddie Mac counts foreclosures as major credit blots for seven years. The company is aggressively pursuing some walkaway borrowers where state laws permit.

The walkaway trend is particularly noteworthy in former housing boom markets – California, Florida and Nevada, among others – where many homeowners find themselves upside down on their loans.

A number of websites have popped up this year claiming to cut the hassles of bailing out of a mortgage. One company promises that clients will be able to live in the home “for up to eight months with no mortgage payments,” after paying $895 for a customized plan.

Another site claims that your credit can be repaired and you will be able to “purchase a house in as few as two years” – after paying a $495 fee. Still another company says walkaways can expect “up to one year living payment free” as the lender goes about filing for foreclosure. That company charges $995 for its how-to-do-it kit.

Fair Isaac Corp., developer of the FICO scores used in most mortgage transactions, is unhappy at any suggestion that a foreclosure could be minimized or wiped away in a short period of time. Its scoring model counts foreclosure as a long-standing and severe event, nearly comparable to bankruptcy, with negative consequences for all forms of credit. That includes credit card applications, auto loans, student loans – even insurance and employment.

FICO spokesman Craig Watts said that the effect of a foreclosure on an individual’s score depends heavily on the payment history, but “it is always significant.”

Robin Stout Migala, consumer outreach manager for Freddie Mac, said that “there are so many bad reasons for walking away” from a home loan. Not only are borrowers’ credit standings wrecked, but they also face other potential problems, including federal income tax liabilities.

Federal legislation enacted last year allows homeowners who negotiate loan modifications with lenders and have portions of their principal debt eliminated to escape income tax liability for the amount forgiven. Walkaways, by contrast, have nothing forgiven, and the IRS may demand income taxes on the balance they never paid, according to Migala.

Many borrowers facing foreclosure have endured serious financial crises, said Migala – loss of employment, medical issues, predatory loans – that led to their inability to make their mortgage payments.

When they apply for a loan from either Freddie Mac or Fannie Mae, she said, the standard application form asks whether they have ever experienced a foreclosure or handed over their deed in lieu of foreclosure. If applicants check “yes,” the loan is immediately shifted to manual underwriting. Every piece of information is scrutinized by underwriters, who probe for the facts surrounding the loss of the house.

For borrowers who faced genuine financial hardships leading to foreclosure, underwriters are likely to be more sympathetic a few years down the road. But if you walk away, here’s the deal: Don’t expect to get a new home loan – certainly not one with favorable terms – for five to seven years.

That’s no matter what some promoter online promised you.

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