Homing In on Solutions to Ease Mortgage Woes
Q: The house my wife and I bought in 1990 is now worth less than the mortgage we still owe; our equity is completely gone. To make matters worse, I have lost my job and we are having to struggle to make the monthly house payment. What would be so terribly wrong if we just let the bank take back the house? Why should we continue making payments that are only sucking up what little money we do have to get back on our feet? --J.S.
A: The answer you want is not cut and dried. There are many factors to consider, including the type of loan you have, the cooperation you can elicit from your lender and the value you place on a blemish-free credit history. Ultimately, your decision will be more a matter of balancing ethics with pragmatism than following an obvious path.
Clearly, you can walk away from your house any time you want; thousands of equity-depleted homeowners across Southern California and the nation are doing this every day, as the bulging rolls of foreclosures at local banks will attest. Looking at your situation strictly from the vantage point of economics, you could easily argue that it makes sense to walk away from house that is worth less than you owe on it. After all, why should you pay more for something than it is worth?
However, before you quickly jump ship, you should carefully consider the consequences. For starters, a mortgage default and foreclosure will severely damage your credit worthiness. A foreclosure can remain listed on your credit reports for up to seven years and could be sufficient to deny you the credit you would need to purchase a car or another house if you should get back on your feet within that time.
Another issue is whether you really can walk away from your mortgage without the bank coming after you for any losses it suffers on the sale of the property. If the loan in question is a “purchase money mortgage”--that is, if the loan in question was secured when you purchased the home--the lender can only go after the asset (your home) that secured the mortgage. However, if you refinanced your home, the terms of your new loan allow the lender to attach any or all of your assets to recover its money.
Practically speaking, lenders are no more anxious than you to be saddled with a huge portfolio with depressed real estate in a declining market. Not only do they face loan losses, but it costs lenders money to maintain and resell the properties they take back from their borrowers.
In an increasing number of cases, lenders are willing to work out a solution with a potentially defaulting borrower. In these cases the lender will accept a “deed in lieu of foreclosure” that essentially gives back the property to the lender without having to go through a formal foreclosure procedure. In some cases, the lender will even agree not to notify credit reporting bureaus of the transaction, sparing the borrower a significant blow to his future credit worthiness.
Before you walk away from your house, you should--at the very least--talk to your lender. Try to secure a deed in lieu of foreclosure. If you meet with resistance from your loan officer, says one mortgage banker, you should take your case to the highest levels of the bank or thrift.
If your loan officer seems to understand your situation, you could reach an agreement to help the lender sell your home, agreeing to maintain the home in showcase condition and escort potential buyers through in exchange for the right to continue living there. If you do manage to strike such a deal, you should secure a forbearance agreement that says the lender will not foreclose on you while you the home remains on the market, despite the fact that you are unable to keep up the mortgage payments.
How to Put Insurance Proceeds to Work
Q: A few weeks ago you discussed requirements for reinvesting casualty loss insurance payments, but you didn’t touch on the one issue I have been trying to get a straight answer on for months. I owned a furniture store that was burned in the Los Angeles riots and do not want to use my insurance money to rebuild in that area. May I use the proceeds to invest in another piece of retail real estate with some new partners? I cannot afford to buy the property I want on my own and need these potential partners. --B.S.
A: Probably not, although it is difficult to give you a direct answer without knowing more about your situation. According to our experts, the replacement rules governing casualty loss insurance proceeds are considerably more restrictive than those governing tax-deferred exchanges of business property.
Section 1033 of the Internal Revenue Code basically requires that insurance proceeds be reinvested in exactly the same type of real estate that was lost. Furthermore, if any of the insurance proceeds were for the value of the lost business, that money must be reinvested in the same type of business. So, if your lost business was a sole proprietorship, you would have to reinvest in a sole proprietorship. If you owned the business real estate as a sole businessman, you could not invest in new real estate in partnership with others.
However, experts do say that creative solutions can be fashioned to cope with the restrictive IRS laws. You should see a qualified certified public account or tax attorney for the best possible advice.
