Letting your home go into foreclosure does have consequences


As job losses mount and Americans are faced with mortgage payments they can no longer afford, many are asking: Should I stay or should I go?

Bailing out on your home loan and opting to rent may make economic sense in some circumstances, particularly if you are saddled with a big mortgage payment on a home that has dropped steeply in value. But there are serious consequences -- financial, legal, emotional and ethical -- attached to the decision.

“There is no angle that you can look at that situation and think it is a great idea,” said Bruce McClary, a spokesman for ClearPoint Credit Counseling Solutions. “It should be saved as the very last option that you have available, and you should look at every possible alternative.”

Turning your back on your home and your mortgage can ruin your credit score even if it is already tarnished by a default on your house note. That could complicate other future financial transactions, including renting a new place and buying a car.

Nevertheless, some say such drastic action should be reserved as an option of last resort, particularly with the number of Americans still “underwater,” or owing more on their mortgage than the home is worth. About 21% of U.S. households in single-family residences found themselves in this situation, reported this month.

Glenn Kelman, chief executive of the online real estate brokerage, contends that giving up should be an option.

“I think there are a lot of people who don’t walk away from their house for moral reasons that are economically irrational,” he said. “The problem is that we live in a reputation-based society, and people will track you down and never trust you again.”

So be ready for that. And also be aware that your credit is not the only thing at risk.

J. Scott Bovitz, a Los Angeles bankruptcy attorney, said a distressed borrower should be prepared for a host of potential legal and tax consequences.

Banks in California can pursue two routes of foreclosure, judicial and nonjudicial, he said.

In a nonjudicial proceeding, which is the most common for someone who owns a home as the primary place of residence, the lender can’t come after you for the money you still owe. A judicial foreclosure, though less common, can result in a debtor still owing the bank money even after the home is taken back.

Even if you escape your lender, Uncle Sam may still come after you. The Internal Revenue Code considers foreclosure a forgiveness of debt and therefore taxable income. If you are insolvent -- your debts are more than your income -- then you could be forgiven that debt, Bovitz said, but some folks might still face taxes after foreclosure. And that can come as a surprise.

Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling, said those homeowners who think they might face a financial shock, such as losing a job, need to seek housing counseling early on. The counselors shouldn’t charge a fee for their services and should be approved by the U.S. Department of Housing and Urban Development.

“The sooner the better, because the longer you wait, the deeper and more complex the problem becomes,” she said.

Walking away should be considered only if another agreement can’t be reached with your lender such as a loan modification or selling the house short of the balance of your outstanding mortgage, Cunningham said.

Some experts have contended that because of the sharp increase in foreclosures during the housing bust, Fair Isaac Corp., which developed the nation’s most widely used credit-scoring formula, FICO, may reconsider how it weighs such transactions in the future.

“The question that FICO will be asking itself is, is a foreclosure in 2008 and 2009 the same as a foreclosure in 1998, 1999 or 2003 and 2004?” said Todd J. Zywicki, a bankruptcy expert at George Mason University School of Law in Arlington, Va.

“This is a once-in-a-century real estate market.”

Fair Isaac spokesman Craig Watts said that though it is too soon to tell how the company might account for the complex mortgages offered during the boom and how they changed consumer behavior, he cautioned that foreclosures still serve as good predictors of consumer behavior in the eyes of FICO and many lenders.

“There is nothing about the recession that changes the dynamic that the score is designed to evaluate,” Watts said. “Yes, there are more people going into foreclosure, but they are not going into foreclosure in dramatically different ways than they have in the past.”