Las Vegas Sun

March 28, 2024

DAILY MEMO: REAL ESTATE:

Upside down? Consider the costs of your options

Consider this hypothetical: Three years ago, you bought a house for $400,000, financed with a $320,000 mortgage that costs $2,240 a month. But the home is now appraised for half the purchase price — so you are upside down — and the most it could fetch on the rental market is $1,200. And the lender won’t refinance. Do you honor your contractual commitment, pursue a short sale or simply walk away?

The decision isn’t an easy one: The three choices almost certainly will hurt your wallet.

Opting for a short sale — when the lender forgives a major portion of the loan principal to facilitate the sale — may mean you can’t buy again for three years. But at least the size of your loss is minimized.

If you walk away and let the home foreclose, your credit report will reflect it for up to seven years. This probably precludes you from buying another home over that period. And you will take a credit hit. If your rating was already low, the hit could be small. If you had a flawless credit record before the foreclosure, that act could prompt a drop of 100 points in your score, says Craig Watts, spokesman for FICO, a company that measures consumer credit risk.

But while those two alternatives — as long as the loan is worth no more than $2 million — carry financial penalties, they could have been worse. Until the Mortgage Forgiveness Debt Relief Act of 2007, Americans had to report canceled debt as taxable income. The act, stretching through 2012, waives canceled debt as taxable income in most cases involving primary residences, according to the Internal Revenue Service.

For a time, a fourth option also would have likely prompted a financial hit, but a potentially smaller one: buying a second home, with a more manageable mortgage, and then relinquishing the first to the lender.

Federal housing officials call this “buying and bailing.” They attribute a chunk of 2008 foreclosures to this practice.

Here’s how it works: Homeowners buy a second property as an investment, indicate they plan to lease out one of their homes and follow suit or perhaps dummy up a fake lease of their upside-down residence and then ditch it.

“They get a 30-year fixed mortgage on the new home, let the other home go and then say, ‘Well at least I have this house,’ ” mortgage specialist Chris Clements says. These homeowners also would take a credit hit.

Housing and federal agencies, including Fannie Mae, minimized this practice in recent months. For example, if homeowners with Fannie Mae mortgages don’t qualify for a second property, the only way they can buy another home is if they have 30 percent equity in the first. Fannie Mae handled about a third of mortgages nationally at the end of 2008.

These new guidelines greatly discourage buying and bailing: If you have that much invested in your home, you’re unlikely to bolt.

Besides the financial implications of the question — “Do I stay or do I go?” — there are legal ramifications to consider: Nevada is a deficiency state, meaning the lending institution can go after the debtor for the unpaid loan.

Christopher Reade, a real estate attorney whose clients include 25 foreclosed homeowners, says it’s uncommon in the valley for banks to go after such debtors, though not unheard of. If a deficiency judgment is approved, a bank could seek wage garnishment, among other remedies.

More common: Lending institutions send tax forms to former homeowners of investment properties, driving some to bankruptcy protection. Remember, only unpaid loans on primary residences under $2 million aren’t subject to being taxed as income.

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