What do I say?

[BHoffman]

Clients are calling and asking me what the consequences will be if they walk away from their mortgages. I don't know what to tell them.

I can suggest that they might receive a 1099-C, but under what circumstances when they surely owe more than the house is worth? So far, I've seen one client who walked off and did not receive a single thing - it looks like Fannie Mae just took the house in exchange for the outstanding loan per the Trustee's Deed Upon Sale and that was it. That house was mortgaged past the hilt and client did not receive either a 1099-A or 1099-C. Any advice?

[AJsTax]

The hit on

their credit rating is the worse thing that would happen now with the exclusion of cancellation of debt income for qualified primary residence. They would have no reportable income if it is qualified acquisition debt. The rules are more complex if the mortgage money is used for other than qualified primary residence purposes. If they do receive a 1099-C then you just do the form to report it as non taxable.

[ChEAr$]

Echo to A J's comment about taking a hit on credit report. They could then kiss goodbye
any hope of buying another personal residence, or even a house, for the next 7 years.

[BHoffman]

The client is already aware of the credit hit. Thanks for the info. I read where if the personal residence debt is incurred 2007 - 2012, the tax on the COD income is forgiven?

[WhiteOleander]

I Googled the topic. I found an article that says it appears Calif. has forgiven "TAX" owed under certain circumstances. I didn't find anything that said the Feds were forgiving tax.

[Lion]

COD on Principal Residence

COD income is excluded for primary residences within limits:

http://www.irs.gov/individuals/article/0,,id=179414,00.html

[Burke]

This is a very troublesome trend. I can understand the motivation for these homeowners. But the long term consequences to the rest of the public are significant. Many of these persons feel they are making a pure "business/financial" decision and are walking away from homes they could very well pay for but don't want to. The big picture is this: whom are they hurting? You, and me, and every other person who has retirement/pension funds invested in these CDO's thru mutual funds or even at a fixed rate of return, as well as any one of us who may at some time in the future want a home loan --- from any institution -- who cannot possibly be inclined to give such loans if everyone can simply walk away from them when they choose.

[BHoffman]

Thank you everyone. AZ is a "non-recourse" state, meaning that lenders cannot come after borrowers who default for any outstanding acquisition debt balance due on a repossessed home. I also saw the info regarding the tax break for certain COD situations.

Burke - I agree.

[ChEAr$]

Consider a neighborhood of perhaps lower than average home values and incomes. Maybe
there are already 10% of the homes with for sale signs, another 10% with foreclosure signs,
and a few people in the area get the idea that it makes financial sense to walk away and
"let the bank have the house 'back'" since theye're underwater. Pretty soon you have a lot of vacant houses which get broken into, they fall into disrepair, inhabited by poachers, and
values of other homes fall since the neighborhood is going downhill.
Yes, a very disturbing trend.

[JohnH]

I don't think I'd ever default on a legal obligation unless I didn't have the ablity to pay, but then I'm not living in a home that is hopelessly under water. Some people find themselves in situations which they can probably never dig out of, so they are technically bankrupt for the long term even if they don't appear to be financially bankrupt in the short tem. For them, strategic default is just recognizing reality. I'm not saying it's right, but it's a fact.

Several clear messages have come out of this whole housing bubble:
1) Regarding the equity in one's home as a significant component of your net worth and/or retirement plan is seriously misguided financial planning.
2) Government interference in the free market system ALWAYS causes disruptions, no matter how well intentioned. Some disruptions are an annoyance - others are near fatal.
3) When unqualilfied people are allowed to borrow money they can't repay to buy housing they can't afford, the general price level is drive to artificially high levels. Eventually everybody pays for the mistakes made by those borrowers and lenders.

[taxmandan]

The big picture is this: whom are they hurting? You, and me, and every other person who has retirement/pension funds invested in these CDO's thru mutual funds or even at a fixed rate of return, as well as any one of us who may at some time in the future want a home loan --- from any institution -- who cannot possibly be inclined to give such loans if everyone can simply walk away from them when they choose.

I would rather keep that money for my retirement by no longer sinking money into a mortgage on a house that will always be worth less than I owe. Deciding whether to fund your retirement by continuing to pay on a mortgage that will never recover value is not going to sway my decision in the least.

No, I'm not looking at defaulting, just saying that the big picture isn't of much concern anymore to people. The gov't is going to steal your pension money anyway, eventually.


Concering the OP, I would lay out the tax affects of a default and stay out of the moral question of the decision.

[OtisMozzetti]

Has this house been used like an ATM in the past?

Clients are calling and asking me what the consequences will be if they walk away from their mortgages. I don't know what to tell them.

I can suggest that they might receive a 1099-C, but under what circumstances when they surely owe more than the house is worth? So far, I've seen one client who walked off and did not receive a single thing - it looks like Fannie Mae just took the house in exchange for the outstanding loan per the Trustee's Deed Upon Sale and that was it. That house was mortgaged past the hilt and client did not receive either a 1099-A or 1099-C. Any advice?

How do we know that this house has not been used like an ATM in the past? Maybe they took cash out, and took out the cash which paid the fees on various past refinancings, during previous years. When refinancings may have occurred, the lenders probably lawfully wrote up the new mortgage as recourse debt. There's been discussion about certain exclusions which apply to limited amounts of acquisition debt, but have we ever been told that acquisition debt is what this situation is? If not, the taxpayers (who are clients or just phone shoppers?) could and should end up owing the IRS big time. There is, on the other hand, another pair of major wild cards used to exclude cancellation of debt income, and those cards are "insolvency" and "bankruptcy".

EA in California

[JohnH]

Here's a pretty good discussion of this entire "strategic default" matter. The very appropriate title of this thread is "What Do I Say?". If I had a client asking the questions, I'd be inclined to give them this article and the links it offers and say they should read it, along with similar articles, and then make their decisions. This is neither an endorsement nor an indictment of the concept, but it is a reality numerous people are dealing with today. (If you believe the numbers, we're talking about roughly 10% of the homeowning population at the moment)

Many of us will get questions about it, especially if we hit the "double dip" that appears to be looming on the horizon. May as well have something useful to hand them along with the clear instruction that it's their decision to make, not ours.

http://www.dailyfinance.com/story/investing/should-you-consider-a-strategic-default-on-your-mortgage/19346468/