Homeowners throughout the U.S. are facing the aftermath of the housing bubble: the ownership of homes that are worth less than the amount owed on mortgages. (This is known as negative equity.) Earlier this year, Zillow published a report indicating that 31.4% of homes were underwater. Governments, lenders, real estate brokers and lawyers are all involved in the effort to understand the scope of this problem and come up with solutions. The following is offered as a basic primer on options for the underwater homeowner.
If you are current on your mortgage and can afford the payments, you have the option of staying put. The mortgage payment is likely to be less than you would pay for rent on a similar residence.
If your mortgage is unaffordable, and you are struggling to make the payments, consider the following options:
Most homeowners who obtained a home mortgage before 1/1/2009 and are experiencing a hardship can apply to the federal government’s Home Affordable Modification Program (HAMP). Some analysts deem this program unsuccessful due to the small percentage of homeowners who receive a permanent modification, but HAMP may still be better than direct negotiation with your lender. California homeowners can also apply through the CALHFA Mortgage Assistance Corporation for a principal reduction of up to $100,000.
Homeowners who are behind on payments may also contact their lenders to apply for a mortgage modification. The lender will evaluate whether it would benefit more from a modification versus a foreclosure and sale of the property. In recent years, few homeowners achieved the desired results from this process, but the large inventory of foreclosed homes may motivate lenders to approve more modifications. This option is worth a try if you are determined to stay in your home.
Short Sale / Deed In Lieu of Foreclosure
A homeowner who does not succeed in getting a modification might consider one of these options. In a short sale, the homeowner gets consent from the lender to sell the home for less than the amount owed. A deed in lieu of foreclosure turns the property over to the lender, also with its consent. The advantage to these options is that the process of getting out of the home could be accomplished faster, and these options may be less stressful than foreclosure.
Note: Proceed with one of the above options only after determining whether you will be liable for a deficiency, income tax or capital gains tax. (More on this in a future post.)
Chapter 13 Bankruptcy
A chapter 13 bankruptcy can help if your home is underwater on the first (senior) mortgage, and you also have a second (junior) mortgage or significant amount owed on a home equity loan. In a chapter 13, you have the ability to “strip off” the second mortgage if it is unsecured (there is no equity securing it). This may be a good option if the first mortgage is affordable, but payment on the second mortgage or home equity debt makes the house unaffordable.
Chapter 7 Bankruptcy
A chapter 7 bankruptcy may be ideal for a homeowner who has explored other options and decided to surrender the underwater home. A chapter 7 will discharge liability for the mortgage, but title to the property remains in the homeowner until a foreclosure or other transfer. The homeowner can wipe out certain other debts at the same time, and live for free in the home while waiting for the foreclosure process to be completed. This can take several months or longer, allowing the homeowner to save money and find a new place to live. Another advantage is that the homeowner will not have to worry about tax liability or owing anything for a deficiency.
Foreclosure (No Bankruptcy)
A homeowner may choose to discontinue payments on the mortgage and let foreclosure proceed, without filing a bankruptcy case. This may be a viable option if all mortgages are nonrecourse loans and there will be no tax liability for cancellation of debt. (Have this analyzed by your attorney and tax advisor.) The homeowner could choose to maintain any credit accounts that are in good standing (such as credit cards) and live in the home for free while the foreclosure proceeds.
Image: Kevin Saff