Home Basics
Homeowners Opt To Pay Debts Over Keeping Homes
Thursday, August 16, 2007
Aleksandra Todorova
SmartMoney.com
Seeing few other options, Mendez � who asked us to change her last name for privacy concerns � put her place on the market four months ago. So far, no buyers have showed interest. Even a successful sale wouldn't completely resolve her situation, however: Mendez owes the bank $295,000, while her house was recently assessed at between $200,000 and $230,000. If she sells the place for less than the mortgage amount, Mendez will have to pay the bank the difference. She could try to get the bank to write off that balance, but then she'd owe regular income tax on the forgiven amount. And while the house is still on the market, the bank has refused to work with her on restructuring her loan to lower her payment. In the meantime, she is bracing for another rate reset in November.
Mendez's situation is unfortunately common these days. Over the past three years, plenty of homeowners with lower credit scores or little cash on hand for a down payment bought homes using 0%-down interest-only or other types of exotic mortgages1. Now, they are faced with the double-whammy of ballooning mortgage payments and deteriorating home values that too often make their homes financially unfeasible to sell.
In an odd reversal of the American dream, many of these cash-strapped homeowners are now deciding to walk away from their homes. Some, like Mendez, are holding onto hopes of selling. Others are taking more drastic measures, such as voluntarily surrendering their home to the bank with what's known as a "deed in lieu of foreclosure," which transfers the property title to the lender rather than start a foreclosure process. Yet others, perhaps in denial of their plight, are simply skipping mortgage payments until the foreclosure notices arrive.
What's even more perverse is that many of these folks are using whatever money they do have to stay on top of their credit cards and other debts instead of their mortgages.
Consider this: During the first quarter of this year, credit-card delinquencies actually dropped 15 basis points to 4.41% compared with the last quarter of 2006, while home-equity-loan delinquencies were up 23 basis points to 2.15%, according to the American Bankers Association. At the same time, the Mortgage Bankers Association reported that 13.77% of all subprime loans were delinquent in this year's first quarter, compared with a much lower 11.5% in the first quarter of 2006. Even delinquencies for prime loans, which go to those with good credit and solid financials, rose to 2.58% from 2.25% in the first quarter of 2006.
Sources: Mortgage Bankers Association; American Bankers Association
The phenomenon is a historical first, according to Leslie Linfield, executive director of the Institute for Financial Literacy, a nonprofit that provides prebankruptcy counseling. However, given the current real estate environment, she notes, it shouldn't comes as much of a surprise. "When you look at a mortgage payment that went up from $1,500 to $2,500 and a credit-card payment at $500, you have to make a choice," she says. "And if you didn't put a lot of money in your home to begin with, psychologically that was just an expensive rental. So you'll take your credit cards and go get another rental."
Also fueling this trend is that mortgage lenders aren't nearly as aggressive in debt collection as credit-card companies, making it easier for homeowners to "keep their heads in the sand," says Richard Schram, a quality assurance manager at the Consumer Credit Counseling Service (CCCS) of Central Florida and the Florida Gulf Coast. "A credit-card lender will be right in your face, looking for payment and wanting to know specifically when you're going to send them money," he says. "A mortgage lender will notify you if you're past due and try to help you work it out. Individuals, we find, tend to avoid their mortgage lender more so than they do a credit-card lender."
Gary Herman, president of Consolidated Credit Counseling Services in Fort Lauderdale, Fla., says this trend � all too common in his area, where homeowners are suffering through one of the biggest real estate slumps nationwide � marks a significant shift in how people manage their finances. "Once people realize that their home is worth less than what they borrowed, their credit cards all of a sudden seem a lot more important to them than keeping their home," he says. "The financial security that was once provided by the equity in their house is now provided by their credit cards."
This shift in priorities has more inherent dangers than many folks realize. "People focus on the minimum payments on their credit cards, but once they max them out, they'll have no choice," Herman says. "They'll have no equity, no credit, and at that point, bankruptcy will be the only option."
This scenario becomes even more likely if you consider the consequences of walking away from a home. Foreclosure notices destroy an owner's credit record and can likely cause credit-card companies to jack up interest rates, says John Ulzheimer, president of Credit.com Educational Services. Granted, your credit score wouldn't drop dramatically if it was already hurt by late payments. But a foreclosure notice on your credit report, just like a "deed in lieu of foreclosure," will very likely keep you from qualifying for a mortgage again in the next seven years.
"What people don't realize is that foreclosure is going to follow them, even if their credit score recovers," Ulzheimer says. Many lenders have "override" policies which allow them to deny a loan because of a negative item on a consumer's report, such as a foreclosure, even if they have a sufficiently high credit score. With the current credit and housing crisis causing mortgage companies to tighten their lending standards across the board, it's likely that more lenders will enforce such rules.
There is some good news for troubled homeowners: Mortgage lenders are more willing to help them keep their homes than ever before. "Lenders absolutely, positively don't want to take your house back. That's not their business," says Todd Mark, director of consumer relations at the Consumer Credit Counseling Service of Greater Atlanta.
Depending on the individual's situation, homeowners can avoid foreclosure through solutions such as loan modification, where missed payments are tacked back onto the last months of the loan or payments are reduced by lowering the loan's interest rate or extending its term. Homeowners who are behind on several payments, but believe they can afford their mortgage obligations going forward, can ask to be put on a repayment plan. Those who are still in a temporary cash crunch have the option of forbearance, which allows them to skip mortgage payments.
Credit-counseling agencies are also stepping in to help consumers negotiate with their lenders. While they receive referral fees from the lenders, their services are free to consumers, explains Mark. To find an agency in your area, start with the Department of Housing and Urban Development (HUD), which has a list2 of HUD-approved credit counseling agencies for mortgage delinquency and default resolution counseling. Another place to go is the Homeownership Preservation Foundation3, a nationwide network of five credit-counseling agencies that offers foreclosure prevention counseling.
Needless to say, working things out is entirely up to the lender's goodwill. Some homeowners are simply too far gone to help, or � as Mendez recently found � lenders simply aren't willing to compromise in certain situations.
For the time being, Mendez plans to keep her house on the market, though she isn't very optimistic. "There's a lot of inventory in Sacramento and my house is very plain," she says. "There's nothing interesting about it and I have no money to update it." If she can't sell by November, when her rate resets, possibly even higher, she'll try renting it out. "I really don't know what else to do," she says.
