When should a homeowner give-up the fight to keep their home?
June 24, 2012
Nash Law Firm, PLLC
By: Stephen J. Nash
Not a day goes by when a client or potential client fails to ask me if they should stop paying their mortgage/s. Unfortunately, there is not a simply answer to that question and, in the end, each debtor has to make their own decision based upon their unique circumstances, how a default will impact them, assumptions they make about the future and their own sense of right and wrong.
That being said, there are some facts that can strongly predict if a debtor will default and there are certain considerations that can be used to help a debtor make the decision to default or not. Even if a debtor wants to remain current on the mortgage, if a property is underwater the debtor is highly likely to default once the property has to be sold for any reason and the greater the property is underwater, the more likely the debtor will strategically default before the debtor is forced to sell.
When I meet with clients who own property that is upside down, I look at three factors to help them to decide whether they are better off trying to keep the property or if they should consider defaulting on the mortgage. No matter what you read or hear, it is not easy for most people to default on their mortgage and it is a common fallacy that most people can simply walk away with no adverse consequences. The fact is, there are significant negative consequences in either continuing to try to keep a property or in defaulting. You are rarely looking to hit a home run; instead, you are simply trying to pick the best option of the two bad options.
I. The Three Factor Test
The three factors we focus on are as follows:
- How long do you want to and/or how long can you live in your home?
- How likely is it that you can continue to make all of the home related payments?
- If there ever is a default on your mortgage/s, what will the impact be on you today versus sometime in the future?
The answers to these questions will go a long way toward deciding whether the home is worth saving and how far the debtor should go in trying to keep the property.
II. How Long Do You Want To Live In Your Home?
If you live in a home that you would be happy to live in for the rest of your life, the mere fact that you are underwater is not a great factor as long as you can afford the payments.
If you can’t or won’t live in the home for the rest of your life, the question becomes: are you able to live there long enough for the house value to eventually rise to the point where you are no longer underwater? This calculation is difficult to determine and involves making a number of assumptions that may turn out to be incorrect.
There are many factors that can force a sale of a home: divorce, illness, death, age, size of family, job change, etc. Sometimes it is easy to presume that one of these factors is likely to occur before the property value recovers. If a person has arthritis that is only going to get worse and will eventually prevent them from going up and down the stairs in the home, the house is going to have to be sold. If a person has a job that is not secure or will most likely result in a transfer to a new location, the house will have to be sold if the owner is transferred or a new job is in a new location.
The second factor can also be difficult to accurately predict – how long will it take for the property value to recover? The property value cannot recover until we have hit the bottom of the market. If the market starts moving upward, is it a temporary bump or has the market truly turned around? Once it is clear that the market has turned around, how long will it take for the property to recover?
Historically, residential real estate values have increased 3 to 5 percent a year. Whatever recovery rate you predict, you can take the present value and do the math to determine how long it will take to recover. You also have to take into account that the sale of a property typically costs the seller about 10 percent of the purchase price, so you will also have to figure that cost into the equation as well.
For example, if the present property value is $60,000.00 and you need to get back to $100,000.00 in order to sell without a short sale and figure a 4 percent gain per year, it will take approximately 13 years to get back to a $100,000.00 value. If the rate of gain is closer to 3 percent it will take up to 17 years and if it is closer to 6 percent it could take as few as 9 years to recover.
If your assumptions about recovery prove accurate, is it really likely that you can wait 9 to 17 years before selling? If not, you will have to attempt a short sale or will have to pay money at closing to make up the difference. If your assumptions about a potential recovery prove accurate, but something unexpected forces a sale (i.e., a divorce or death) before the recovery, you will also be facing the prospect of either a short sale or having to pay money at the closing.
III. How Likely Is It That You Can Continue To Be Able To Make The Mortgage Payment/s?
If you barely are able to make your mortgage payments today and have no savings to dip into, is it likely that you can continue to make the mortgage payments indefinitely? What if the car breaks down? What if you are hit with medical expenses?
How stable is your income stream? Is it likely to go up, stay the same or go down? If you work for a company that is struggling, are you at risk of being laid off? If your income drops, will you be able to find another job in the same location that restores your income stream?
Even if you believe that you have no reason to sell your home before the property values have recovered, you will not have that option if you cannot continue to make the mortgage payments.
IV. If You Default On The Mortgage/s How Will It Impact You Today Versus Tomorrow?
The following are considerations to be contemplated when looking at the potential impact on yourself if you default today versus tomorrow.
A. Multiple Mortgages
If your lender sues you (if you have multiple mortgages you have to assume that all of the lenders except for the first will sue you), how will that impact you? If you cannot survive the garnishing of wages or the attachment of money from your banks accounts, you could be forced into bankruptcy. If you have no assets that the lender(s) can go after, it may have little impact on you.
B. Tax Consequences
A hidden factor that is not getting much consideration is that the temporary law that allows most home owners to avoid paying taxes on debt forgiveness expires at the end of 2012. If this law is not extended (and there is no talk that it will be), you will have to pay tax in the future on something that you would not have to pay a tax on today.
C. Vulnerability to Collection Actions
If you have a job, your wages will be garnished. If you have a bank account, all of the money in that account can be seized. If you have personal property that is not exempt from seizure by a judgment creditor, the creditor can take that personal property. If you own real estate that is non-exempt, the creditor can foreclose on that property.
Certain assets are protected such as 401K accounts, homestead properties up to $300,000.00 and assets held in certain trusts.
A non-protected asset can be indirectly protected if it has no equity. In other words, a cabin is not propertied but if there is a mortgage on the property that exceeds the value of the property, why would a creditor foreclose on this property? Legally the creditor has the right to foreclose, but as a practical matter they would have no incentive to do so.
In some instances, with time and proper planning, a debtor can improve the protection of their assets against creditors. In other instances, the debtor does not have the time required to protect their assets, or have waited too long and legally cannot protect their vulnerable assets from their creditors.
If a person has nothing left to lose, they are more likely to default today because they are judgment proof and probably would qualify for bankruptcy. If a person has assets that they will likely lose to either the lender or through bankruptcy, it is less likely that they will default.
D. Availability of Bankruptcy
While anyone can file bankruptcy, a debtor must now “qualify” for a Chapter 7 bankruptcy to liquidate debt. The first step in qualification is the debtor’s income. If the debtor makes too much income (based upon the area you live in and the number of dependents that live with the debtor), the debtor will not qualify. While the debtor can still file a Chapter 13 bankruptcy, the cost is substantially more expensive, you do not liquidate all of your debts and the bankruptcy plan is going to stretch out over years versus months.
If the debtor qualifies for bankruptcy today and expects to receive a raise of income in the future, that debtor may not be able to qualify for the same bankruptcy when the additional income is realized. Therefore, the odds are much greater that the debtor will default on the mortgage now to file bankruptcy. If the debtor does not qualify for a Chapter 7 bankruptcy now and is vulnerable to judgments, it is less likely that they will default especially with respect to the second mortgage.
One of the factors that have gone from barely a reflection to now a dominant consideration, is the desire for resolution.
In the aftermath of the real estate implosion, everybody wanted more time to try to save their home. Stop the foreclosure! I just need time for the economy to recover, to get a loan modification or for the value of my home to recover. But now, after 5 years of waiting, struggling and worrying, people are becoming worn out. They are tired of waiting for a recovery that never seems to gain any traction. They have given up hope that their lender will ever work with them and they simply want a resolution.
The longer the debtor has been struggling to save the property and the less optimistic they are about their future, the more likely they will default today.
F. Stress/Risk Tolerance
Most Americans facing these real estate problems are feeling tremendous stress and have felt this stress for quite some time. In addition, many people have grown blind to the options before them. During the boom, Americans failed to recognize the risk associated with their decisions and instead focused only on the potential upside. Today, many of those same Americans can only see the downside and have a very low tolerance for taking any risk. They would rather stop the bleeding than hope for a gain. Fear has replaced greed.
If a debtor has a low tolerance for risk, they are going to choose the option they believe has the least downside as opposed to the option that has the best upside. The more likely they believe they will be forced to sell before the value has returned to the property, or that something bad will happen to force a default in the future, the more likely they will chose to default today and force a resolution.
G. Impact Today Versus Impact Tomorrow
The impact on the debtor will change with their circumstances. If the debtor has no assets today, the debtor is judgment proof. If the debtor gets back on his/her feet and accumulates assets, he/she suddenly is very vulnerable. The opposite is also true – if I am making good money today but am likely to be laid off in the near future, a debtor is more vulnerable today than once they lose their job.
A debtor who is in a tough financial situation today but sees a bright future, is more likely default today because he/she is less vulnerable to collection than they expect to be in the future.
IV. To Default or Not to Default – The Decision.
Since your decision on trying to keep your home is based on many assumptions of what will happen in the future, there is a great deal of risk that your decision may turn out to be flawed. Who in 2005 could have predicted what was going to happen to the values of assets and the economy in the United States and the world? Every year somebody predicts that the real estate bottom has been reached, yet at the end of the year we find out we have still slid down even further. Someday they will be correct, but the reality is that we are dealing with a historic economic event that we have no precedent to help us predict what is to come.
Make your best educated guess based upon the facts as you know them, factor in how much risk you are willing to take, how much stress you are living with and choose the option that best fits your situation and achieves your goals.
Don’t listen to anyone who has a one size fits all solution. Don’t listen to anyone who has a solution with no downside. Don’t let someone else tell you what is best for you in your situation. While we can help you through the process, only you can decide what is truly best for you.
The foregoing is not intended to constitute legal advice for any specific circumstance, but is intended to reflect broadly applicable principles, under Minnesota law, relevant to a typical situation. Each set of facts and each contract is, or can be unique; the unique facts and specific language of the contract may require a different legal analysis and may result in a different outcome. Before proceeding in reliance upon this or any other general description of law, consult with an attorney competent in the field of practice relevant to your situation.
Copyright 2012 Nash Law Firm