(Westcoe Realtors, Riverside California)…Unfortunately, this is a question that has been posed to some of our real estate agents far too often in this challenging market. For all the reasons that have been so widely documented, this question is on the mind of many homeowners…and while we are not attorneys or tax professionals, we do have some idea of the general nature of the consequences if you, indeed, simply walk away from your home. However, before we can give you a simplified response to this question, we need to offer a few definitions first.
Basically, there are 3 ways you can “lose” your house…short sale, foreclosure, and simply walk away…and it is important you understand the difference between the three.
SHORT SALE…In this example, the homeowner negotiates with the note-holder(s) to accept less than what is owed so the homeowner can sell the home. The note-holder takes a loss on their loan (which they were probably going to have to do anyway), but is saved from losing even more money by having to complete the foreclosure process. The plus for the seller is that potential tax and legal issues are no longer on the table, since the lender “accepted” the loss. This is generally the best for everyone, but also the most difficult to arrange, since many of the loans are not even owned by the originating bank anymore, and communication with someone who can actually make a decision is almost impossible. But it is worth a try.
FORECLOSURE…Here, for whatever reason, nothing could be worked out with the existing note-holder(s) and after a lengthy process, the home is actually “sold” back to the note-holder at a public auction. Once the note-holder gets the property back, they sell the home in whatever way they desire (real estate agent, auction, bulk sale, etc.). In this process, there are minimal tax consequences for the person who lost the home, but there can be legal issues, depending on how your original note was written, what type of loan was on the home, and the mood of the lender. For this, you would need an attorney, since there are too many variables to cover them all here…just be aware legalities may be hiding around the corner.
WALK-AWAY…In this case, the homeowner, for whatever reason, simply leaves the keys on the counter, and tells the lender the house is theirs. In essence, the homeowner simply walks away…and this has some serious repercussions which is why we are covering it in today’s blog.
Lastly, before we can finally answer the walk-away question, you must understand the role Freddie Mac and Fannie Mae play in just about every real estate loan made in our country.
Banks and Mortgage Companies actually meet with potential borrowers, explain loan programs available, qualify the borrower, and eventually make the loan…but the money for the loan is generally coming from Fannie Mae and Freddie Mac. Once this new loan is made by the bank, they have a piece of paper (the note) but no cash…so they sell the note to Fannie Mae or Freddie Mac, get more cash, and now they are back in the lending business…and Fannie Mae or Freddie Mac get the monthly payments. This is a simplified version of how the lending world works. SO…since the money essentially comes from one of these two wall street giants, ALL LOANS ARE WRITTEN TO FREDDIE MAC AND FANNIE MAE GUIDELINES. They are the giants that set the rules by which everyone must play…or they will take their money and go home, and there won’t be much to lend. It’s their way, or the highway.
Now that you have a little background, we can move on to the answer of what happens if you simply walk away from your home.
First, Fannie Mae will ban you for up to 5 years from receiving a real estate loan in which they are involved, and even after that 5 year time span has passed, they will require a 10% down payment and a FICO score of at least 680. A FICO score is a number that reflects, through a complicated and somewhat secretive process, your creditworthiness. All lenders use this scoring system, and the higher the number, the better. Fannie Mae MAY give you a loan after 3 years if there is documented hardship as to why you left your home, but the key word here is documented…and since you simply walked away, there is generally little documentation on file with the lender to support your position.
Freddie Mac is even tougher. They can count your walk-away against you for up to 7 years, and are currently reserving their right to pursue legally whatever deficiency rights they may have under the terms of the note…so you might want to consult an attorney on this one, as each note is written differently.
Also, on a walk-away, you may have significant tax consequences. Simply put, you may have to pay taxes on the balance of the loan you never paid back to the note-holder. In a short sale, the note-holder “forgives” your unpaid balance, so you have no tax issues…and in a foreclosure, the property is “sold” for it’s current value, so the tax liabilities are basically moot. However, in a walk-away, the note-holder didn’t forgive anything, and the property was not “sold” back to the lender…so the tax burden can be totally your responsibility. This is potentially a huge issue, and I would highly recommend that you consult a tax professional before simply leaving your keys on the counter.
The bottom line here is that it may sound cold, but the lender lent you the money, and you agreed to pay…and your agreement to pay was not contingent upon your keeping your job, spouse, house value, health, or whatever. Yes, there are extenuating circumstances that can lead to real and unexpected problems with your ability to pay, and they can mitigate your situation…BUT YOU NEED TO TRY TO WORK WITH YOUR NOTEHOLDER TO ATTEMPT A SOLUTION. If you don’t, and simply give into the temptation to “just walk away”, then the consequences can come back to haunt you in many ways, for many years.
No one likes what is happening to the families who are having trouble with their house payments…but our best advice is to communicate with your note-holder, and then at least consult with an attorney and tax professional. The good news is that the laws regarding this current housing situation are changing rapidly, so perhaps the government will enact some new programs or regulations that will make all of this less penal…so we again suggest you consult an attorney or tax professional for any up-to-the-minute changes…because what you don’t want to do is make a bad situation turn into a really horrible situation.