To say that these are difficult times in the real estate market would be an understatement. The melt down began with an extended boom fueled by cheap money followed by a rapid contraction of the credit supply. This lethal combination has led to an unprecedented decline in housing values. I have no doubt that the real estate market will come back and thrive. However, in the meantime, does it make financial sense to stay in a home that is underwater; where the value may not come back for 10-15 years and you may only be paying interest on the loan? What is a person to do?
The mortgage industry and government would like us to feel a moral obligation to repay our debts. The argument goes that we are sending the wrong message to our children and community if we default on a loan where we had the ability to make the payments. Never mind that Wall Street banks and investors are voluntarily defaulting on office building, hotels and commercial properties across the nation. Morgan Stanley recently decided to stop paying on five San Francisco office buildings and no one is saying they have a moral obligation. It was a strategic decision to let the properties go rather than invest more money.
A decision to voluntarily or strategically default on a loan can be a very emotional decision. However, if we take the emotional side out of the equation, what does it look like from a purely financial and legal standpoint? From a legal standpoint, there are three questions when contemplating a default on a home loan. They are the following: 1) how will default affect my credit? 2) will there be any personal liability from the default? and 3) will there be any tax liability? In addition, from a financial standpoint, how does the continuing payment of this debt affect other areas of my life?
As a general rule, under California law, a short sale or foreclosure can remain on a person’s credit for up to 7 years. Personal liability on a home loan is determined by the character of the loan at the time the loan was originated and then by the manner in which the lender chooses to foreclose. Generally, a loan or loans used to purchase a 1-4 unit property occupied by the borrower will have no personal or tax liability unless it is excluded loan product such as many types of governmental loans such as VA loans. On the other hand, home loans which were not used to purchase a 1-4 unit property occupied by the borrower such as refinances, lines of credit or loans on investment properties, may have both personal and tax liability.
Even after considering the legal issues, we still need to think about a voluntary default from a financial point of view. Is being “house poor” causing you to not properly fund your retirement, your children’s college education or preventing you from paying bills as they come due or taking your family on vacation?
In conclusion, a voluntary default may be the right decision for you just as it was for Morgan Stanley. It was a business decision for Morgan Stanley and it should be for you too. This is a complicated area of the law, but a real estate or bankruptcy attorney should be able to make to an analysis of your particular situation fairly quickly which will allow you to decide if a voluntary default is the right decision for you and your family.
WE ARE A DEBT RELIEF AGENCY. WE HELP PEOPLE FILE BANKRUPTCY RELIEF UNDER THE BANKRUPTCY CODE. THIS INFORMATION IS NOT PROVIDED AS LEGAL ADVICE AND SHOULD NOT BE RELIED UPON IN MAKING ANY DECISION REGARDING A VOLUNTARY DEFAULT, SHORT SALE, FORECLOSURE OR BANKRUPTCY. THIS INFORMATION IS NOT A SUBSTITUTE FOR OBTAINING TAX & LEGAL ADVICE REGARDING AN INDIVIDUAL SITUATION.
© 2010 Joan Grimes