Mortgage woes pose dilemma

April 17, 2010 

In the real estate industry, new terms are coined as the need arises. On a recent trip to the Lower 48, we were in an area with a high foreclosure rate, and we heard an interesting new phrase -- "house arrest." This means that you owe more than your home is worth (so your house is considered "underwater"), but you can still afford to make your mortgage payment.

Another phrase is "strategic default," in which you just walk away and let the bank foreclose, even though you can afford the mortgage payment.

While the Anchorage market is still relatively flat and the foreclosure activity relatively light, the story is different in California, Florida, Michigan, Illinois, Arizona and Texas where more than 60 percent of the total U.S. foreclosures are occurring. This is where the terms "house arrest" and "strategic defaults" are most in use.

In 2009, strategic defaults made up about 25 percent of the total foreclosures. The other 75 percent were homeowners with financial problems triggered by an unexpected event, such as a job loss.

So why would people just walk away if they can still make payments? Below are both sides of the strategic-default argument.

THE PAY-YOUR-DEBTS ARGUMENT

One side says that you have a contractual obligation, even if your investment is worth less than you owe. To walk away from this obligation goes against society's social and moral conscience.

So to maintain order, society has developed a credit-scoring system as a quantitative way to financially measure an individual. A good credit score is a badge of honor and has definite advantages to the consumer. A credit score over 740 brings you the best possible interest rates. However, a score of 680 or less results in higher interest rates, and eventually someone with a low credit rating could have difficulty obtaining financing.

While the method of formulating the credit scores is secret, observers say that late payments might affect your credit score by more than 100 points. A foreclosure makes getting another home loan next to impossible for at least three years, and that problem could last up to as many as seven years, depending on circumstances. Being late on your mortgage payment more than twice in 12 months -- without a darn good reason -- also makes it difficult to get another home loan.

Credit scores not only affect whether you can buy a home, but can increase a loan's interest rate, the amount required for a down payment or the amount you pay for insurance.

In the tight Anchorage rental market, your credit score can even affect whether a landlord will rent to you or not.

Threats of bad credit scores provide an incentive to pay off your bills, or, at the very least, to pay bills on time. Threats of a possible judgment or a tax obligation for the unpaid loan balance can also scare most people into making their mortgage payment.

THE WALK-AWAY ARGUMENTOn the opposite side of the strategic-default argument is the philosophy that paying an underwater mortgage is financially irresponsible, even if you can afford it. After all, isn't the American way to start over and try again, even for businesses that default? Why should society view the entrepreneurial spirit of a business investment different from an individual's home investment?

Another argument: the current system forces homeowners to shoulder a disproportionate amount of the responsibility of the national housing crisis, instead of lenders sharing a larger portion of the pain. Although current government programs are aimed at providing financially troubled, defaulting owners with help and encouraging banks with incentives, loan modifications seem to be heavily weighted in favor of lenders to minimize their losses.

Proponents also insist that less than 1 percent of lenders will come after a defaulting homeowner, making judgments against homeowners unlikely.

Additionally, the Mortgage Debt Relief Act of 2007 exempts forgiven and restructured debt on your principal residence from taxable income and liability through 2012.

This leaves lenders with mostly a single strategy: threatening to damage your credit score. So if a homeowner decides to just walk, the consequence of this is paying rent for three to seven years, while saving and paying off other bills instead of struggling with the financial indebtedness of an overpriced house. In the hardest-hit real estate markets, renting has become far cheaper than paying an underwater mortgage.

So who is right? Is there a middle ground?


Clair and Barbara Ramsey are local associate brokers specializing in residential real estate. Their column appears every month in the Anchorage Daily News. Their e-mail address is info@ramseyteam.com.

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