What should you do if the amount of your mortgage is greater than the value of your property? If you are the owner of the largest residential property , you may choose to abandon the mess to your creditors and move on with your life and it is best to walk away from mortgage.
In 2010, the American real estate investment firm Tishman Speyer abandoned the 11,000-unit Stuyvesant Town and Peter Cooper Village developments in Manhattan. It was one of the largest defaults in history, yet the company continued to operate. Tishman Speyer simply followed in the footsteps of numerous commercial real estate companies that came before it.
However, if you are a residential mortgage holder, your mortgage default will likely look different (it is unlikely to be as clean and easy). Still, you may be surprised to hear this recommendation: Mathematically speaking, sometimes walking away is the most prudent option.
Sometimes walking away from a residential mortgage is the best course of action.
During the Great Recession, many homeowners, including those with sufficient income to cover their mortgages, decided to walk away after their homes lost value. According to some experts, it may be prudent to walk away from a mortgage whenever it is possible to rent a comparable property for less than the monthly mortgage payment.
During periods of rising interest rates, holders of adjustable-rate mortgages whose homes have lost value are more likely to abandon their loans.
If leaving is your best option, be organized and have a plan for your next residence.
When Walking Away Is Reasonable
Prior to the national housing bubble of the late 2000s, it was generally expected that real estate prices would rise over time. Nationally, the value of homes increased over time, despite the fact that a small number of geographic regions occasionally experienced declines. This had previously been the long-term trend in the United States.
In 2008 and 2009, however, property values plummeted (at times, posting double-digit declines in value). As 2009 ended and 2010 began, 23.1% of all mortgages in the United States were underwater, meaning the amount owed on the mortgages exceeded the value of the homes. At this point, the previously unthinkable occurred: borrowers who can still afford to make their mortgage payments chose not to.
If you can rent a comparable house at less than the cost of the mortgage, some financial experts suggest that walking away from a home is a prudent financial decision. In a situation where you are underwater on your mortgage and facing rising interest rates (as a result of an adjustable-rate mortgage), the incentive to walk away may be alluring. (When a housing crisis occurs, renters are frequently the biggest winners.)
Calculating the Cost of Abandoning a Mortgage
Comparing the cost of rent to the cost of a mortgage is a straightforward calculation. A mortgage calculator is a tool used to estimate monthly mortgage payments.
Determining how long it will take for your home to regain its lost value is a somewhat more complex endeavour. Using a 5% annual value increase provides a ballpark estimate based on national averages. A little research can help you adapt to regional and local market conditions. Consider the following:
• Original cost: $400,000 • Current price: $300,000
• Loss in value: 25%
If real estate values increase by an average of 5% per year, it will take this home six years to reach its selling price. This brings the owner to the point of break-even, but there is no profit to show for it (and the owner has paid interest on the loan every year). If prices fall by another 10%, the recovery will be further delayed. Clearly, home price appreciation is not guaranteed.
• Original price: $400,000
• Value after 25% decline: $200,000
• Value following another 10% drop: $180,000
The recovery period has now exceeded eight years.
Methods for How to Get out of a Mortgage
A short sale, a voluntary foreclosure, and an involuntary foreclosure are three of the most common methods for abandoning a mortgage. When a borrower sells a property for less than the amount owed on the mortgage, this is known as a short sale. The buyer of the property is a third party (not the bank), and the lender receives the entire sale price. Either the difference is waived or the lender obtains a judgement against the borrower. The borrower is then required to pay all or a portion of the difference between the sale price and the original mortgage balance.
Short sales are an alternative to foreclosure, but not all lenders will agree to them.
In a voluntary foreclosure, the homeowner voluntarily surrenders the property to the lender. To arrange a voluntary foreclosure, communicate with your bank and make arrangements to hand over the property's keys. While this procedure will negatively affect a homeowner's credit score, additional mortgage payments are no longer required.
The lender initiates involuntary foreclosure for nonpayment. The lender utilizes the legal system to reclaim the property. The lender will make an active effort to collect on the debt, and the homeowner will ultimately be evicted, despite the fact that the homeowner is frequently permitted to live in the property for months (at no cost) during the foreclosure process.
The Double Standard
The Double Standard Businesses routinely reduce their workforce and reorganize their debt. This can harm (and sometimes destroy) the unpaid suppliers. However, these are regarded as "good" business decisions, and the stock prices of these companies typically increase as a result.
When a homeowner attempts to make the same decision, however, the legal system is designed to protect the lender's profits. While only a minority of banks will agree to a homeowner's short sale, all are willing to foreclose.
A level playing field for consumers and businesses will indeed mean that homeowners should feel no more remorse for defaulting on a loan than businesses that default or even have properties foreclosed. As the playing field is not level, borrowers who default must be willing to accept the repercussions, which can include credit damage, harassment by collection agencies, and years of difficulty obtaining credit.
The Bottom Line
If, after completing your research, you determine that walking away is the best option, be ready. Before you leave your current home, you should purchase a new, smaller home or rent an apartment to ensure you have a place to live. Purchase a vehicle and any other expensive items requiring financing before your credit score is lowered, and set aside cash to ease the transition.
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