I've spoken to three different homeowners in the last four days who were seeking advice to either try for a loanÂ modification, short sale, or let the home go toÂ foreclosureÂ auction. (I was a distressed Asset Manager for a large investment fund, working with homeowners and investors across the country, so this is right up my alley).
Each of the homeowners has a unique situation with specific challenges to overcome.
What's consistent about these people is they're $125-250k underwater in their property, 8-15 months delinquent on theirÂ mortgageÂ due to job losses and income interruptions that depleted their savings, and maxed out their credit cards just to keep the electricity on, food on the table, and gas in the car. Basically, they've just barely hung on during the Great Recession.
What are the risks?
The biggest concern they had was having to pay income taxes on the deficiency balance on either a short sale or foreclosure.
One of the only good things George W. Bush did while in office was pass the Mortgage Forgiveness Debt Relief Act in 2007, that doesn't penalize underwater homeowners who walk away from their properties. Before deciding to walk, make sure to run the 1099-C by a CPA first.
Another concern is how a foreclosure or short sale will appear on their credit?
I find this funny when people are facing imminent bankruptcy, that they want to know if they should let the house go or work with the bank on a short sale. IT DOESN'T MATTER! If they're filing BK because they have $50,000 in charged off credit cards, and few deficiency balances on repossessed cars, along with a charged off Home Equity Line of Credit (HELOC), don't worry about it.
They're going down big and it's going to take 3-5 years to rebuild financially. Credit scores can bounce back within a year or two after a BK, going from a 450 FICO to a 700+ FICO pretty easily.
With an impending BK, my advice is to stay in the house rent-free for as long as possible, hopefully saving money for deposit on a rental home when the inevitable arrives. Just make sure to pay for Homeowners Insurance to insure valuables and against personal liability of someone breaking their leg on the property or getting golf clubs stolen from their car (falls under Homeowners Insurance, not Auto Insurance).
To stay, sometimes it makes sense to hire a foreclosure defense attorney, if one can afford it. Attorneys can file numerous motions that prolongs the inevitable, potentially up to three years. In Florida, attorneys advertise on billboards, "For $300/mo, I can keep you in your house for two years."
If a person cannot afford an attorney, search online for info-sharing groups of homeowners who have represented themselves against the banks. There's a lot of good info out there and many people willing to share their experience, free of charge.
If not a foreclosure defense attorney, filing that inevitable BK will delay the foreclosure sale, placing an "automatic stay" on the property while the bankruptcy is active.
I have a few friends who filed and discharged a Chapter 7 BK in 2009. Their bank forgot about them. They've both been there for three years. Each time the mortgage lender calls them, they say, "We filed bankruptcy." The collector immediately apologizes and hangs up. It's illegal for a creditor to call a debtor while they're in bankruptcy.
The great thing for the homeowner about the big bank servicer call center collector, is that the collector is on a predictive dialer and must make 30-60 phone calls per hour. The turnover rate is horrendous in those jobs, so chances are they won't remember the same homeowner telling them for the past three years that they were in bankruptcy. Nor, are they trained well enough or savvy enough to log in to PACER and verify if that bankruptcy had already been discharged.
So the loan just lingers in no-man's land, maybe getting back into the dialer in another 3-6 months.
At this point in the housing crisis, moral judgment on paying ones mortgage has been thrown out the window since The Fed,Â Treasury, Bush and Obama administrations chose to useÂ HAMPmodifications to "foam the runway for the banks" rather than provide homeowners with a long-term option to keep their homes.
If a cash-strapped homeowner needs a free place to live until they get back on their feet, by all means go for it. The banks don't want more distressed inventory on the market, so they'll play along with a homeowner pushing the foreclosure out another year or two. Homeowners have to do what's in their best interest because the banks and the government are not coming to their rescue.