Some 12.8 million borrowers in the United States are underwater on their home loans, meaning they owe more on their mortgage loan than their homes are worth. For many of these underwater borrowers it will be years before they see any equity in the property. Others will succumb to foreclosure
and lose their property to the bank.
But what happens when you walk away
from a mortgage loan?
It depends on what state you live in and what kind of loan you have — a recourse loan or a non-recourse loan.Non-Recourse Loans
In a non-recourse state, borrowers are not held personally liable for the outstanding loan amount — at least not with the lender. Lenders may recoup some of its cost through foreclosure, but the lender can’t sue the borrower for additional funds (known as a deficiency judgment). If the foreclosure sale does not generate enough money to satisfy the loan, the lender must accept the loss. In non-recourse states, you can turn over the keys and walk away, free and clear.
But the Internal Revenue Service (IRS
) considers debt forgiveness
as income. Therefore, you might owe the federal government money. A law passed in 2007 makes that forgiven mortgage debt not taxable by the federal government, but that law is set to expire at the end of this year. Also, your credit score will take a hit, but you can rebuild it over several years.
Each non-recourse state has its own anti-deficiency statutes that prohibit lenders from seeking judgments. In some states— such as California — non-recourse laws apply only to “purchase money” loans (i.e. original home loans that are used to purchase a property). Mortgage refinances do not constitute “purchase money” loans. So, if you refinance a “purchase money” loan, it becomes a recourse loan.Recourse Loans
Recourse loans are different. Recourse borrowers owe the full amount of the mortgage — even if they deed the property back to the bank. The lender can foreclose on a delinquent borrower, sell the property for less than the mortgage, and come after the borrower for all the rest — plus real estate selling commissions, legal fees, carrying costs and other expenses.
Moreover, refinanced loans, second mortgages, and “cash out loans like home equity lines of credit (HELOC loans) are generally recourse loans. Here’s some help tax advice from the IRS and the California Franchise Tax Board
Talk to a real estate attorney before making a walk away decision, and show your lawyer the mortgage contracts.
Readers what do you think? Should non-recourse borrowers walk away
from underwater properties to avoid a foreclosure
? Or is walking away from mortgage debt illegal and immoral? What are your thoughts? Sign up for a free trial
for full access to RealtyTrac's address-level foreclosure data nationwide.You may also be interested in the following articles:Strategic Default “Only Choice” for Some Short Sale Tax Tip: Mortgage Forgiveness Taxable in 2013Are Mortgage Write Downs a Backdoor Bailout for Bankers?Will Principal Write-Offs Increase Foreclosure Discounts?