Strategic Default: Business, Not Personal | Bankrate.com

Dear Real Estate Adviser,
We bought a beach property in 2006 just before the market collapse and paid top price. We keep paying the mortgage and insurance and other expenses, but I'm almost 70 years old and really can't afford it. I've suffered cutbacks in my wages, and my wife just retired. We'd love to stop paying the mortgage and pay down other debts. We thought of a short sale or just walking away in a strategic default. What's a good plan to get out of this?
-- E. Jeffries

Dear Jeffries,
As you probably surmised, there are few graceful exits. But let's go over some options. Just mailing in the keys (sometimes called "jingle mail") and walking away is probably a bad idea if you live in a recourse state, where a bank may file a deficiency judgment against you for the difference between what you owe and the amount your house fetches at a sale. In such cases, it's conceivable the lender could go after your nonretirement assets. In a nonrecourse state, such as California, Florida or Texas to name only a few, the bank has few remedies beyond repossession. Warning: Such "strategic defaulters" may be issued a 1099 form where the forgiven debt counts as income in the eyes of the Internal Revenue Service if the home in question, such as yours, is not a principal residence.

To get your lender to approve a short sale or another similar bank-sponsored program, you'll have to demonstrate a financial hardship, which is probably possible in your case, given your loss of family income. But short sales consume time and tend to fall apart at some point because there are so many moving parts.

Bankruptcy is an option, but bankruptcy codes aren't as friendly as they used to be. Laws now typically prohibit the court from reducing the mortgage balance to the value of the filer's home, but it's also worth noting that a deficiency judgment resulting from a short sale or foreclosure may be dischargeable in bankruptcy. If you did work out a deal with the mortgage lender in a bankruptcy, make sure there's a hard-and-fast agreement included for the satisfaction of your loan.

Most of the time, it's far better to at least try to work with the lender than just giving up. You could try to refinance or ask for a loan modification, although you may have already discovered there isn't sufficient equity in the home to merit that. You might inquire about the Home Affordable Refinance Program for Fannie Mae or Freddie Mac borrowers and the recently proposed Obama administration refinancing plan to see if you can gain any relief there.

You could try to rent out the place and wait for the market to turn, but that could be a long, long wait, and you may not have the luxury of that time. Besides, any rental income derived will likely not come close to covering your monthly obligations.

Or you could sign the house away in "deed in lieu of foreclosure," though that can wreak as much havoc on your credit rating as a foreclosure. A bad credit rating not only hampers your access to credit, it can make it harder to get good insurance rates, which can be a real issue for some fixed-income senior couples. But if your car, credit card payments and other debts are up to date, that can buffer the effect and make it possible for you to earn a decent credit rating three years post-foreclosure or even earlier. As an aside, while I don't advocate default, I believe it's more of a contractual issue than a moral one. Ironically, even the Mortgage Bankers Association was forced into a short sale of its Washington, D.C., headquarters building, which it bought for $79 million in 2007 and sold for $41 million three years later!

I strongly suggest you talk with a seasoned tax lawyer, accountant or real estate attorney in the state where the beach house is located. Good luck to you!

To ask a question of the Real Estate Adviser, go to the "Ask the Experts" page and select "Buying, selling a home" as the topic. Read more Real Estate Adviser columns and more stories about mortgages.

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Source: http://www.bankrate.com/finance/real-estate/strategic-default.aspx

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