With the recent turmoil in the housing and lending markets, there are a lot of people dealing with a mortgage that's not only upside-down, but with terms that simply cannot work.
Loan modification efforts have been largely ineffective as banks are just not willing to work out a plan that's reasonable. Given this problem, what can you as a homeowner do? Should you just walk away from your house? Should you fight to save your home? It all depends on the numbers and the options available.
The Main Options
Walk Away
Many people are realizing that they just bought too much house. It's not their fault, as the lending industry was aggressively selling people into loans that they shouldn't have. It's completely understandable, since we trust our banks to offer us only loans that they feel are suitable for our income. The problem is, of course, the repackaging and selling of subprime loans allowed lenders to profitably offer non-qualified applicants loans and then just sell them off and limit their risk. Combine that with the commission driven sales approach and it became almost like walking on to a car lot. People were pressured and convinced that they could buy a million dollar house on a $60k salary.
Now, it's all come crashing down and homeowners are the ones paying for it. Given that context, I would just want to walk away as well. But what are the risks?
Deficiency
The main risk is the possibility of being sued for the deficiency when the house is sold. Imagine that million dollar house from which you walked away having put no money down. The bank sells it for $700k, and then sues you for the $300k deficiency. Now, you're without that house AND you owe $300k.
There are laws in various states the prevent lenders from seeking deficiency judgments, but in general most states will allow a deficiency judgment be made.
Deed in Lieu of Foreclosure
A deed in lieu is essentially a contract between you and your lender that say you will hand over title to the house in return for the lender not bringing a foreclosure action against you. This saves the bank all the legal fees of bringing the foreclosure lawsuit, and allows you to negotiate with your lender to help limit potential financial responsibilities of a deficiency upon the sale of your house.
In many cases, you can offer to deliver the bank your house in good condition in return for an agreement not to pursue a deficiency judgment against you. Now, whether the bank will agree often depends on just how big the deficiency is. If the bank is going to lose $200k, then it may be hard to negotiate a favorable deal.
"Fight" the Foreclosure
Another option is to allow the bank to start the foreclosure, then hire an attorney to defend the lawsuit. Depending on the details of how you got your mortgage, whether it's been sold to another lender at some point (they are often several times actually), whether the lender violated any lending laws, whether the lender can actually prove that they own the mortgage (you'd be surprised how many foreclosure lawsuits are tied up because the lender has lost important paperwork) or several other issues.
Trying to defend a foreclosure action is a combination of legal skill, art, and negotiations. Finding a balance that will get the lender to modify the loan to avoid a fight is often the solution in cases like this.
Bankruptcy Options
Chapter 7
If you file a chapter 7, a pending foreclosure will be halted, but only temporarily. It may work if the reason your mortgage is in trouble is because of other debts that are tying up your income. For example, if you've fallen behind on your mortgage because you are struggling to balance a ton of credit card debt, then it may work.
Let's say you've got yourself into $50,000 of credit card debt and it's eating up your income. If you file a chapter 7, you'll get rid of all of that debt. Will that be enough to allow you to catch up on past mortgage payments and continue with your current home loan? If so, then you may be able to negotiate with your lender during the bankruptcy, letting them know that once your debts are discharged, you will get back on top of your mortgage, but you may have to come up with the mortgage debt right away, which can be very difficult to do.
Chapter 13
If you file a chapter 13 bankruptcy, you'll have some more options. Primarily, you can work the past due mortgage debt into your monthly bankruptcy payment plan and pay it off over three to five years. That credit card debt will be repaid at some amount, depending on how much money you earn, but the mortgage debt comes first. That means if you only make enough to pay towards your monthly expenses, the past mortgage debt and the monthly mortgage payment, most of that credit card debt may simply be discharged in the bankruptcy.
See this post on Chapter 13 Payments for more on how the payment plan works.
The above are the most common options you will have to deal with your foreclosure. Of course, the first step is to beg and plead with your lender to modify your loan, get into a trial loan modification, or whatever you can do. Unfortunately, it's become apparent that most people won't be able to do it without using the legal system in some way, whether fighting a foreclosure suit or getting the bankruptcy court involved.
If you're thinking about your options in a case like this, check out Nolo's book on Foreclosure. It goes into great detail and can walk you through all the options and help you decide if you should fight to save your house, or call it a day, walk away and avoid a deficiency.
