Do I Stay ... or Do I Go Now?

The unprecedented level of home price depreciation has resulted in a number of borrowers handing over the keys and walking away from their mortgage. How many? It is not clear, but the unprecedented level of delinquency and foreclosure suggest that the depth of the mortgage problem is unsurpassed historically.

Should you continue to pay your mortgage if you owe more than your house is worth?

Emphatically, the answer is YES! And here's why ...

First of all, you signed a binding, legal document called a mortgage. It is legally enforceable in a court of law. And, there are a number of remedies available to a borrower, particularly given the recent Mortgage Modification Plan issued by the Obama administration.

Second, the damage to your credit is substantial. Any default on a debt as large as a typical mortgage is a huge "red flag" on your credit bureau report and will diminish your ability to get credit in the future. Lenders were more forgiving in the past, allowing a borrower who defaulted the ability to get credit within 3-4 years after the blemish. Given current risk averse behavior by lenders, I would expect lenders to be much more cautious in the future about granting credit to borrowers with a default in their credit history. That being said, your lender might consider the circumstances of the default. Rest assured, however, that you will be considered a subprime borrower in the future and your rates on all forms of credit will be 2% or more higher, particularly credit cards (if you can get them).

Finally, consider your other housing options. A home has "utility", meaning it has value beyond that of a financial asset. If you move out of your home, where will you live? Will your kids need to change schools? If your time horizon is fairly long, it is entirely possible that your negative equity situation will have time to reverse itself. However, the days of seeing your home increase in value more than 2-4% per year are long gone. And, the days of using your home like an ATM or for funding your retirement are gone too. But your home has value to you and your family and you must consider those "costs" and "benefits".

And the housing cycles are regional. Look at your local economy - is the community growing, are there jobs and companies expanding, are the schools high quality, are there amenities in your community that make people want to live there? Those factors will affect your home value - ignore the media! Those of us in Ohio never enjoyed the luxuries of large increases in home values anyway and we've managed over the years.

And do contact family members who might be able to help you ... perhaps a sale of your home to a family member who leases it back to you is an option.

However, if you believe you were a victim of predatory lending or that some sort of fraud was perpetrated by the lender, you might have legal recourse. You must select your legal advice very carefully, however, because you could end up spending a lot of money on legal advice only to end up on the "bad" end of a legal outcome. There are plenty of attorneys out there who are not well-versed in the complexities of mortgage law. Further, beware of any "fraud" you might have perpetrated in the process of obtaining the mortgage ... for example, did you "embellish" your monthly income? While I am sure you did not, there is plenty of evidence to suggest borrowers lied about as often as the mortgage brokers did in getting mortgages approved.

If you decide to move ahead with turning over your home or, if you just want to explore the options, see the following steps.

Step One: Contact your mortgage's servicer. Contact information is all over your monthly statement or in your coupon book. Be patient. The level of automation makes talking to a "real" person frustrating. But, the US government has largely mandated that lenders work with borrowers.

The Mortgage Modification plan put forth last month by the President sets guidelines for servicers and lenders to work with borrowers in making their mortgage affordable. The plan gives the servicer several options for converting adjustable rate mortgages (ARMs) into fixed rate mortgages, allows the servicer to extend the mortgage up to 40 years to reduce payments, and allows the borrower to work with Fannie Mae and Freddie Mac to refinance a mortgage, even if the loan-to-value (LTV) ratio is as much as 105%. If you can make your payments, however, skip to Step Three.

Step Two: Seek out community and state programs that help borrowers stay in their homes and avoid foreclosure. Contact a state agency like HUD or a local community organization for resources. Again, if you can make your payments, skip to Step Three.

Step Three: Ask your servicer about a "short sale" or "deed in lieu". These are tried and true options that allow the borrower to step away from a mortgage under terms agreed upon by the lender/servicer and the borrower.

A "short sale" involves selling the property at today's market prices. The lender then agrees to accept the proceeds of the sale as full payment. The lender writes off the deficiency as a loss and the borrower owes nothing more after the sale is completed. Now, this may be a long, drawn out process if the home does not sell within a few months. The borrower needs to access the desirability of the property and work with the lender on choosing this option.

A "deed in lieu" involves essentially handing over the keys to the lender, charging the lender with the responsibility for selling the property. Again, the borrower and lender negotiate and typically, the borrower owes nothing, and the handover of the property can be done more quickly.

Remember, if a lender takes your property in foreclosure it has to take on tremendous costs too - legal and court costs, realtor commissions, property maintenance expenses, etc. The lender may see the two options above as a way to manage these costs down and actually reduce their loss on your loan.

Step Four: File bankruptcy. The reality given today's federal guidelines is that a mortgage cannot be discharged in bankruptcy if the mortgage is for your primary residence. However, the House just passed a measure, supported by the Obama administration, that allows a judge to modify a mortgage including writing off principal owed by the borrower to the lender. However, the Senate Republicans and moderate Democrats are blocking the measure from coming up for a vote in the Senate. If the Senate approves the measure, it is likely to be more narrow in scope than what the House has approved. It is likely to apply only to subprime mortgages and will require that the borrower has already attempted to work out payments under the Mortgage Modification plan detailed here. The bankruptcy can discharge your other obligations, again with damage to your credit.

The decision to stay in home that has declined in value is an important one. Your home is more than an asset to you and to your family and the decision is not to be taken lightly. There are tremendous and lasting consequences to "walking away" and the consequences can not be taken lightly.