Ill and underwater: Give up the house?

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Dear Real Estate Adviser,
I bought a home back east for $518,000 when prices were high. Eventually, I was forced to move 2,100 miles away to Idaho to take a job to pay that mortgage. (The lender wouldn’t approve a short sale, saying I made too much!) Now disabled from a stroke and fighting cancer, it seems less and less sensible to worry about my good credit, especially with the lender still refusing a short sale. Moreover, they lose every document I send. The house is valued at $365,000 and I’m underwater, owing $425,000. I have a 401(k) account. Can they take that? How do I get out from underneath this?
— Terri K.

Dear Terri,
I am sorry to hear of your physical and fiscal ills and wish you a robust recovery on both fronts.

As for your top-heavy mortgage, it’s a sad fact that thousands of conscientious homeowners such as you, who are still making their mortgage payments, find it a painful challenge to identify a graceful exit. It’s especially tough as you observe many homeowners just walk away from underwater properties in “strategic defaults” — even though they aren’t suffering extenuating circumstances such as yours. I wouldn’t blame you a bit for feeling that you’re suffering greatly for doing the right thing.

First, however, I wonder if you’ve been able to effectively communicate your change in circumstances to your document-losing lender. Before submitting yourself to the foreclosure you’re apparently considering, you should produce a new hardship letter for the lender that delves directly into the medical expenses and new financial issues you’re facing, especially now that you are disabled. (Try sending it by registered mail.) The bank may consent to renegotiating your mortgage terms to avoid a short sale or the expense of absorbing yet another foreclosure. Make plenty of copies of anything you send the lender, by the way. Documents that support money-losing propositions can be very low priorities in lender offices.

A more radical option is to offer the bank the house in a deed in lieu of foreclosure proceeding. That’s where you essentially state that you can’t make your payments and believe foreclosure is inevitable, so you are handing over ownership to the lender. In such an agreement, the lender may agree to forgive some or all of the deficiency balance it would no doubt incur after sale of the property. A little good news: Any such debt forgiveness previously resulted in taxable income for its beneficiaries prior to passage of the Mortgage Forgiveness Debt Relief Act of 2007, which has been extended through 2012 for loan balances that are $2 million or less.

If the lender doesn’t forgive your balance, it could well come after some of your assets, but not retirement savings plans because 401(k)s and IRAs are not considered liquid assets in most legal actions. On the other hand, assets in stock accounts and savings and checking accounts can be pursued.

Before you do anything, I strongly suggest you consult with a financial adviser or an attorney — or both — for advice on how to proceed, especially given your circumstances. Such professional aid may set you back a bit, but it may also save you a lot of grief and money in the long run.

Good luck!

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