Thinking of walking away from your mortgage?

If you own a house that's now worth a lot less than what you owe on your mortgage, and you're thinking of walking away, you are not alone.Nearly one-quarter of U.S. mortgages, or about 11 million loans, are "underwater," i.e. the houses are worth less than the balance of their loans. While home values are regaining ground - median prices rose 10% in Southern California in the month of February to $275,000 compared to a year earlier - they remain far below the July 2007 peak of $505,000. Many are choosing to "strategically default" on their mortgages. That is defaulting on the mortgage, even though you could afford the payments. While I wouldn't advise anyone to strategically default without exploring other options like a short sale, it is an option you may want to consider if you're stuck in a home with a huge loss that you don't expect to ever recover. This option can be especially helpful in these tough times if you need to relocate in order to work again At the beginning of the mortgage crisis homeowners struggled with emotional ties to their homes as well as remorse about reneging on an obligation. That has changed as more homeowners have concluded that the housing market isn't going to rebound quickly and they'd be better off cutting their losses because most experts predict that prices will take years to reach the pre-crash peak. And according to some economists, this can be as long as 15 years in California. Further, the average American is fed up with hearing how they're supposed to honor their debts while businesses operate by another set of rules. Case in point: Maguire Properties Inc., one of the largest commercial landlords in California, walked away from seven prime office buildings in Los Angeles and Orange counties last year, defaulting on loans worth more than $1 billion! However, nothing comes without risks. If you choose to do this, you will face the possibility that a bank will try to collect any shortfall on the amount due on your mortgage such as a deficiency judgment and there are tax consequences involved. You should work with an attorney to minimize the likelihood of being sued for the shortfall. In California there are rules on when a bank can seek deficiency judgment. This all depends on how the bank forecloses on the property once you walk away from it. In California, lenders may foreclose on deeds of trusts or mortgages in default using either a judicial or non-judicial foreclosure process. The judicial process of foreclosure involves filing a lawsuit to obtain a court order to foreclose. This is used when no power of sale is present in the mortgage or deed of trust. Generally, after the court declares a foreclosure, your home will be auctioned off to the highest bidder. Using this type of foreclosure process, lenders may seek a deficiency judgment and under certain circumstances, the borrower may have up to one (1) year to redeem the property. The non-judicial process of foreclosure is used when a power of sale clause exists in a mortgage or deed of trust. A "power of sale" clause is the clause in a deed of trust or mortgage, in which the borrower pre-authorizes the sale of property to pay off the balance on a loan in the event of their default. In deeds of trust or mortgages where a power of sale exists, the power given to the lender to sell the property may be executed by the lender or their representative, typically referred to as the trustee. Lenders may not seek a deficiency judgment after a non-judicial foreclosure sale and the borrower has no rights of redemption. In addition to the first mortgage, if you have a second mortgage on the property you must determine whether your second mortgage loan is a non recourse loan or a recourse loan. This is important because a non-recourse loan is a loan that the bank can only look to their secured interest so they do not have to be paid back after foreclosure. However, the big mistake homeowners made during the real estate boom is turning a "non-recourse" second loan into a "recourse" loan by refinancing it. So how is a second mortgage a non-recourse loan? Simple, it was "purchase money" for your home. A purchase money loan is one where the money went from the lender, to escrow, and then to the seller or to pay purchase closing costs. In California, purchase money loans made on your home (note: not second home or investment properties) are non-recourse. With regards to the tax consequences, you should consult with a tax expert to assess your particular situation. One tax consequence is you may be liable for having to pay taxes on any debt that a bank forgives. There is a provision in the federal tax law that may exempt you from having to pay taxes up to the first million dollars; this provision is set to expire in 2012. However, some states still expect you to pay taxes on any forgiven debt after a short sale or foreclosure. Again, consult with a tax expert before proceeding. So if you are stuck in a home that doesn't have a chance of regaining its value in 10 or 20 or maybe more years, this is one option you should keep in mind. After all, this is a business decision. The purpose of this column is to provide general information on the law, which is subject to change. It is not legal advice. Consult a lawyer if you have a specific legal problem.

********** Published: March 26, 2010 - Volume 8 - Issue 49