Sun Sentinel: To Walk Or Not To Walk: Underwater Homeowners Face Dilemma

I was interviewed for this article which ran in Friday’s Sun Sentinel.  In working with real estate investors, we have been dealing with the pros and cons of so-called “strategic defaults” for some time now.  Most foreclosure defense lawyers have the task of keeping people in their homes.  Although this is a noble goal, it often does little more than delay the foreclosure.  On the other hand, the homeowner or investor who is upside-down typically wants nothing more than to extricate himself from the mortgage and its attendant personal liability.  This owner wants no part of delay, even if he can obtain a successful loan modification.

More and more articles are finally alerting homeowners to the real issue in this crisis:  the significant number of properties that are upside down. Most owners simply cannot come to terms with the realization that their property is totally worthless (actually negative) in value.We all hear  the question, “when will this foreclosure mess be over?”   My answer is simple:   “When the banks and government either accept the premise of principal reduction or everyone who is upside down returns the property to their lender.”

As Prof. White  points out, the policy of fear and shame has been persuading homeowners to continue paying their mortgages even though it may be clearly against their interests to do so.   In many instances it is only a matter of time before the borrower runs out of money and can no longer do so.   Having depleted his savings, he looks back wondering why he didn’t make the decision sooner.  How long can the banks and our government depend upon homeowners acting in a financially irrational manner?

Fri 05 Mar 2010

By Paul Owers, Sun Sentinel

Michael Keigans is “underwater” on his mortgage, owing $80,000 more than his Deerfield Beach house is worth.   Keigans figures it could take a decade or two to recover the lost equity, so he’s tempted to walk away, even though he has the money to pay. “Why keep putting money into a house that’s going down in value?” he asks.

It’s a question being debated in many households nationwide as the housing crunch continues. Some borrowers feel they have a moral obligation to pay the mortgage, but a growing number of homeowners and consumer advocates say walking away could be a smart business decision.     The scale of the problem is daunting: More than half of all residential mortgage holders in Broward County are underwater, California research firm First American CoreLogic said last week. In Palm Beach County, nearly half of mortgage holders fall in that category.

And there are several reason for the crisis: Homeowners who now are underwater have seen their property values plummet after they paid peak home prices from 2004 to 2006. Many of these borrowers bought with adjustable-rate mortgages, putting little or no money down. Some are underwater because they refinanced their homes at the market’s peak.

So should they walk? Hundreds of thousands of people are doing just that.    Keigans, 36, is considering it, too. First, he wants to try to unload the house in a short sale, in which a buyer would agree to pay current market value — probably no more than $200,000 — and his lender would forgive the remaining debt. If that doesn’t work, he sees little choice but to walk away.

But borrowers have to weigh several practical considerations of so-called strategic default. They risk being sued by the lender for the unpaid mortgage balance for up to 20 years. Their credit will take a huge hit, making it difficult to get a credit card or a car loan. And the poor credit rating could affect future employment and mean higher auto insurance rates.

Some homeowners, unable to strike deals with their lenders, are willing to face those consequences for the opportunity to shed burdensome mortgages.   “There is no easy way out,” said Guy Cecala, publisher of Inside Mortgage Finance, an industry newsletter.   In a recent study, global information services company Experian and consulting firm Oliver Wyman estimated that 588,000 borrowers nationwide chose to walk away from their mortgages in 2008, up 128 percent from 2007. The taboo of abandoning homes appears to be dissolving amid the mortgage meltdown, the report said.

Those who walk away and let their homes fall into foreclosure can expect to see their credit scores drop by 200 to 300 points, said Shari Olefson, a Fort Lauderdale real estate lawyer. Foreclosures stay on borrowers’ records for 10 years, and they won’t be able to get other mortgages for at least two or three years, she said.

“We should be encouraging people to meet their obligations,” said Olefson, author of Foreclosure Nation, a book about the housing downturn. “It’s the right thing to do. We should be setting a good example for our kids.”    Florida law allows lenders to seek personal judgments if homeowners default on the mortgage. The increase in homeowners walking away likely will result in more lawsuits from lenders seeking to recoup losses, credit counselors say.

There may be tax issues, too. If lenders forgive the mortgage debt, borrowers who walk away from investment properties risk having to pay federal income taxes on the forgiven amount. Forgiven mortgage debt through 2012 is not taxable income on a primary residence as long as the debt was used to buy or improve the house.     “We don’t think [walking away] is a good option for homeowners,” said Nancy Norris, a spokeswoman for banking giant Chase, which lends in all 50 states. “A mortgage is a contract. We expect you to pay the money back that you borrowed.”

But sometimes that doesn’t make financial sense, said Brent White, a University of Arizona law professor who wrote a research paper in December on underwater borrowers.

White contends that most underwater homeowners stay put to avoid the stigma of foreclosure and because of the “exaggerated anxiety over foreclosure’s perceived consequences.” Borrowers who have good credit before they walk away can rebuild their credit rating within two years of the foreclosure, White wrote.

He said homeowners should make decisions in their own best interests, without worrying about “unnecessary shame and guilt and fear.”     Lenders and other businesses break contracts without considering morals or ethics, White said.   He points out that securities giant Morgan Stanley announced plans in December to hand back to its lender five San Francisco office buildings to get out of the loan obligation.      “We have a double standard,” White said. “It’s indefensible.”

But legal, Cecala said. Businesses often buy assets by setting up corporate entities that protect them from liability. Generally, most underwriters for residential mortgages require borrowers to be on the hook personally.    Edward Sunshine, a theology professor at Barry University, says borrowers and businesses should honor their contracts if they have the financial means to do so. Deciding to walk away from a mortgage in anticipation of financial problems that have not yet happened is rationalization, he said.   “Our whole economic system is based on trust,” he said. “It is important for people to fulfill their obligations and do what they said they’d do.”

Keigans, the Deerfield Beach homeowner, bought the property for $327,000 in 2005. He didn’t make the February mortgage payment of about $2,100. And if he walks, he thinks he’ll be able to rebuild his credit faster than the house would regain the value of his mortgage.    He said he doesn’t feel the least bit guilty. He blames the banking industry for creating the mortgage mess by lowering lending standards to make homeownership attainable for many Americans who couldn’t comfortably afford it. The increased demand helped push prices to record highs.    “The financial minds that made these decisions had to know that someone making $40,000 a year couldn’t repay a $400,000 loan,” Keigans said.

Boca Raton resident Hilton Wiener said reaching out to lenders often is a waste of time.    Wiener  has tried unsuccessfully to make deals with his lenders on 10 underwater investment properties he owns across Florida. But he said they won’t work with him, either refusing to take back the properties or rejecting offers for short sales.    Unwilling to deplete his savings to cover the mortgages, Wiener has stopped making the payments. He said his first responsibility is to his family — not the banks.
“You have to make choices in life,” he said.

Walking Away From Your Property