Upside down in your mortgage? Consider credit before walking away
Short sales, deed-in-lieu deals damage credit as badly as a foreclosure
Dear New Frugal You,
Help! I'm trapped in my home. I can afford the mortgage payments, but I feel stuck. My wife and I owe way more than the house is worth. Can't sell it or refinance it. And it looks like it will be years before anything changes. Is there anything I can do? I never bargained for this. Am I really obligated to keep paying this outrageous mortgage? -- Housebound
Housebound, you're asking a question that affects many homeowners today. The average home price is down 30 percent nationwide from its 2006 peak. In many places prices aren't expected to return to their peak for 20-plus years.
According to a one study, as of September 2010, there were 17 counties in the U.S. in which more than half of all homeowners with mortgages owe more than their homes are worth. So are you really housebound? The answer is: That depends on how you evaluate both the financial and ethical aspects of walking away from your home. Let's look at both.
First, the financial news. There are three ways that you can move out of your home without paying off the entire mortgage:
- Foreclosure: When the bank kicks you out.
- Short sale: When your lender agrees to let you sell the home for less than the mortgage.
- Deed-in-lieu of foreclosure: When you give the bank your home and walk away. Sometimes this involves what the industry calls "jingle mail," named for the sound an envelope makes when someone mails house keys to the lender.
All three will negatively affect your credit score even if you've never been late on a single mortgage payment. According to FICO, the creators of the FICO score, a short sale or deed-in-lieu of foreclosure is treated the same as a foreclosure. Your score will drop between 85 and 160 points, depending on how high your score is now.
How long will it take for your credit report to recover? If you're current with all your other payments and stay that way, your score should begin to improve in two or three years. But it will take seven to 10 years for the negative information to be rendered obsolete and deleted from your file.
During that time your credit score will affect other things. Don't be surprised if both your auto and home insurance rates increase. It will also be harder and more expensive to borrow money. It might even affect your ability to find a new job or enter college.
You'll also want to find out if the lender can come after you for the difference between the mortgage and home sale price. The rules vary by state. In some, if you have other assets, the mortgage company may force you to use them to pay the difference.
Finally, in some cases, forgiven debt is considered taxable income. A recession-inspired law temporarily blocks the IRS from collecting forgiven mortgage debt, but that exception is limited and expires after 2012.
Yet, even given all that, you may decide that a major dent on your credit score is a fair price if that's what it costs to walk away from being tied to a mortgage for 20 years.
Which leaves an ethical issue to consider. Are you morally obligated to continue paying the mortgage? Just because you can?
Some would argue that your responsibility ends with the contract. If you leave the home and it doesn't cover the mortgage that's the lender's problem. They understood the risks when they agreed to lend the money. Some would even say that the lender talked people into borrowing money that they shouldn't have borrowed.
On the other side are those who say that you gave your word to repay. As long as you are capable you need to honor that commitment, that argument goes, no matter how galling it is to face foreclosure to a bank that got a government handout to keep its own Corinthian columns from crumbling. Only you can answer the ethical question.
It's a difficult decision you're facing: years of being tied to a mortgage versus losing your home and your credit rating. But if you should decide to leave your home, the best time to do it is now. The sooner you start, the sooner you can put the damage behind you.
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