Should you walk away from your home ?

by Paul Staley
Saturday, 06 September 2008 20:02

Foreclosures and foreclosure-related bankruptcies are in the news again. So surprise there. The latest issue of "California Lawyer" magazine has an article discussing the growing number of bankruptcies that have their roots in those "stated income" loans, sometimes euphemistically called "liar loans", because, well, the borrower doesn't really back up anything he / she says on the application. Those loans seemed smart to lenders when times were better and home values were soaring, Now, not so much. Other higher-than-normal-default ratio loans: the so-called ARM option loans, the ones where the borrower can choose to pay an abysmally small payment at the outset of the loan.

No surprise here, either: lots and lots of people paid the absolute minimum thinking they'd refinance at a fixed rate when...the value was higher or interest rates were lower (?) No one ever really expected them to be able to pay the full payment on these loans. The bursting real estate bubble dashed a lot of hopeful expectations, no one's more than these borrowers. The September 6, 2008 Wall Street Weekend Journal cites an increase to 9.16%, from 6.52% just a year ago, in the ratio of loans that are at least months past due or in the foreclosure process.*

Borrowers in California are discovering a painful irony about this squeeze. As property values have plummeted, leaving them "upside down" in their homes, many of them can still qualify for a loan to buy one of those cheaper homes - maybe a bank-owned property right next door. Yet they are unable to refinance their own homes because of that pesky "loan to value" issue.

Some are playing a trump card in this situation: walking away from one home even as they are purchasing another, now far less expensive one. For many, there is relatively little downside risk to this play other than a big fat ding on his / her credit report. That's because California has an 'anti-deficiency' statute that protects homeowners from being sued - except to take the property back - by the lender that laid out the cash for them to buy the home. I call these "no-fault foreclosures", mostly because they sort of resemble a no-fault divorce in that if you want it, you get it, and because the consequences can be contained. [Some divorcees will I'm sure only wish the consequences could be contained as well.]

Caveat: the law doesn't protect the borrower from being sued by other lenders, so there is danger from, say, a lender that refinanced, or extended a home equity line of credit. And the number of homeowners who haven't refinanced over the past few years has shrunken considerably.

Should you walk away? It's a question that requires a whole lot more information to answer. Be careful.