mortgage

Walking away from mortgage is costly

Highlights
  • Voluntary foreclosure can trash credit, increase taxes.
  • Damage can limit future rental, job options.
  • Several alternatives offer better outcomes.

Call it the fast unraveling of the American dream.

Americans are losing their properties at an alarming rate. The national foreclosure rate now stands at 3.3 percent, and more than 11 percent of all mortgages are either delinquent or in foreclosure, according to the Mortgage Bankers Association.

In most cases, homeowners end up in foreclosure because of a job loss or a gimmicky mortgage with a rate that resets so high the homeowner no longer can afford to make the payment.

However, some homeowners who can afford their mortgage -- even if they struggle to make the payment -- may be tempted to abandon their dwellings simply to get a financial fresh start.

Such a decision can have dire and lingering financial ramifications, experts say.

"Unfortunately, people can often be most victimized when they're scared about their financial well-being," says Stephanie Bittner, community education and outreach coordinator for Consumer Credit Counseling Service of Delaware Valley.

Credit killer

A homeowner's credit score is among the biggest casualties of any foreclosure, whether voluntary or otherwise.

Missed mortgage payments and defaults wind up on your credit report, where they remain for seven years, says Barry Paperno, consumer operations manager at Fair Isaac Corp., which computes credit scores for reporting agencies Equifax and TransUnion.

The negative impact is huge.

An individual with previously super credit who walks from a home can suddenly find his or her FICO score plummet "by at least 100 points," Paperno says.

Defaulting homeowners with lackluster credit won't shed as many points because they don't have that far to fall. But the net result will be the same.

"Either way, you'll wind up at the bottom," Paperno says. "In a nutshell, it's serious."

To avoid the credit damage of a foreclosure, some homeowners look to an alternative known as a "short sale." Under a short-sale agreement, lenders allow borrowers to sell their homes for less than their loan amount -- say, $250,000 instead of the $300,000 mortgage balance -- then forgive the difference.

In some cases, short sales will not damage the homeowner's credit profile. 

"If they're reported as 'paid satisfactorily' or something similar, there will be no negative impact," Paperno says.

However, if a short sale is reported as "settled for less than the full amount due," the short sale "will have the same impact as a foreclosure,'" Paperno says.

Foreclosures and short sales don't just ravage your credit score today, but also hamper the ability to stabilize your life and finances tomorrow.

Plan on renting after you abandon the home you own? You may have to scramble to convince a landlord that you'd make a reliable tenant -- a tough sell if you've left your mortgage lender with hefty unpaid debt.

Employers may also check credit reports of prospective employees, particularly if the job requires overseeing or handling money.

"Someone with poor credit may not be seen as trustworthy," says attorney Dianne Coscarelli, a partner with Thompson Hine in Cleveland who chairs the American Bar Association's mortgage lending committee. "To an employer, they may steal money or not make as good an employee as someone without that financial baggage."

Time is the only cure for credit damage related to a default. After seven years, a foreclosure will be removed from a credit report. However, it is important to note that with each passing year, a default will have less of an impact on your credit.

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"A foreclosure from a month ago will hurt you more than one from five years ago," Paperno says.

Tax consequences

Foreclosures and short sales also may trigger a bigger tax bill, depending on the kind of home you're leaving.

The IRS views unpaid debt -- including mortgages -- as income. In official tax parlance, it's known as "cancellation of indebtedness income."

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