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Under Water on Your Home? Get Advice Before You Give Up On Your Mortgage Payments

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What should you do if you have been struggling to make your house payments for a while and you need to get out from under it?  Many Americans are struggling in terms of what to do about the sagging real estate market.  For most homeowners, their loss in the value of their homes over the last couple of years is a bummer but does not immediately affect their lives.  They may have lost the “investment” upside they thought they were acquiring when they purchased 5 or 10 years earlier, but they are enjoying their homes and are paying down their mortgages.  Perhaps they’ve even been aided by the downturn by refinancing their mortgage loan to take advantage of historically low interest rates.

For some, however, the recession has profoundly and adversely affected their financial well-being.  Unemployment is still well over ten percent.  Many people have lost jobs or have had their business income greatly reduced over the last couple of years, making it difficult or impossible to continue to make ends meet.  If they purchased a home in 2004, 2005, or 2006, they may very well be upside down in their homes.  In other words, they may owe more in mortgage debt than the value of their home.  Combine this circumstance with the need to move to get a job or to reduce housing costs and they face a substantial dilemma.  What is the best way to get out from under that mortgage payment?

1=35010">This story highlights the issues but is also a significant oversimplification.  Before you develop an action plan, you need to identify all of the issues that should be addressed. Here are just a few key questions that one should be able to answer before deciding what to do:

1.    Do I qualify for a loan modification under one of President Obama’s Making Home Affordable Programs?  
2.    If so, does my servicer participate?
3.    If so, will the modification solve my problem?  
4.    Am I subject to personal liability on the debt?
5.    How would I go about conducting a short sale?
6.    How would I get the bank to agree to a short sale?
7.    Assuming I am successful getting my lender to agree to my short sale and assuming my lender will expressly forgive part of my loan, might I owe taxes for the debt forgiveness?  
8.    Is there anything I can do to minimize the adverse effect on my credit?

Unfortunately, this is not a simple topic.  All of the potential scenarios have downsides, but some may be better the others, depending upon the circumstances.  The following options are often considered:

1.    Loan modification.  The federal government had hoped that voluntary programs like HAMP (Home Affordable Modification Program) would result in a substantial number of loans being modified to an extent that would allow borrowers to stay in their homes throughout the downturn in the economy.  The problem, however, is that these programs did not seem to offer adequate incentive to change the business model employed by loan servicers.  That business model contemplates very little interaction with their borrowers and, thus, a very high ratio of loans to employees for servicing.  In essence, banks do not typically have the capacity to conduct the work necessary to successfully negotiate loan modifications.  If you have a mortgage that is owned by or guaranteed by Fannie Mae or Freddie Mac, the loan servicer is must participate in the program, but you’ll need to be prepared for a difficult process. Secondarily, the fact is that many borrowers need to get out of the loans altogether, such as the scenario painted above, so a modification may only prolong the problem.
2.    Short Sale.  The idea behind a successful short sale strategy is to cut everyone’s losses – the banks and the borrowers – by obtaining current market value for the home to apply to the existing loan balance.  In theory, it cuts losses on the bank’s side because the bank can avoid the time and expense associated with foreclosure and the further servicing of a loan that is not performing.  However, many servicers actions suggest that a failure to recognize this concept.    
3.    Foreclosure.  There are obvious problems with allowing your home to go to foreclosure.  First, the effect on your credit is typically severe.  It will likely be many years before your credit can recover.  From the bank’s perspective, foreclosure and re-sale is an expensive and time-consuming process.  In a stable real estate market, a bank can expect to lose upwards of 15-20% of market value.  
4.    Walk away or deed-in-lieu of foreclosure.  Aside from the obvious benefit of expending no mitigation effort, this choice simply has the potential for too many negative consequences to be the appropriate choice in the vast majority of cases.
5.    Bankruptcy.  Although Chapter 7 is not designed to save a debtor’s house from foreclosure, Chapter 13 may allow a debtor some room to catch-up on any arrearage.  In cases where is no equity in the home to cover any portion of it, a lien securing a second mortgage loan may be stripped from the property, which would have the effect of rendering the second mortgagee an unsecured creditor for purposes of the plan.  There are eligibility requirements for Chapter 13 that can eliminate it has an option.  For example, the debtor cannot exceed either of the the secured and unsecured debt limitations and the debtor must have “regular income” as that term is defined by statute.   

There are a number of legal and practical considerations that may dictate how a family handles this situation. In addition, the type of financing involved (FHA insured, Fannie/Freddie-owned, 80/20 piggyback loans) may be important determining answers to the questions posed above.    The key point is that one should not be afraid to reach out for help.  A consultation with a real estate attorney familiar with mortgage law issues can be invaluable.