By Kenneth R. Harney
Saturday, April 12, 2008
The country's two largest sources of mortgage money have a blunt warning for anyone thinking about joining the growing "walkaway" trend, in which homeowners stop making payments and months later send the house keys back to their lender: You will feel the pain.
On March 31, Fannie Mae sent out new guidelines to lenders aimed at walkaways and other foreclosure situations. The giant investor will now prohibit foreclosed borrowers from getting another mortgage through it for five years unless there are "documented extenuating circumstances." In those cases, the mortgage prohibition is for three years.
Even after five years, a borrower with a foreclosure in his file will be required to make at least a 10 percent down payment and will need a FICO credit score of at least 680.
Freddie Mac, Fannie Mae's rival mortgage-finance firm, counts foreclosures as major credit blots for seven years, and a senior official said the company is now aggressively pursuing some walkaway borrowers "to preserve our deficiency rights" where permitted under state law.
The walkaway trend is particularly noteworthy in former boom markets -- California, Florida and Nevada, among others -- where many homeowners find themselves upside down on their loans, owing tens of thousands more than the current market value of their houses. If they invested little or nothing in down payments, some owners reason, continuing to make payments, even if they can afford to, may be throwing good money after bad.
A number of Web sites have popped up this year claiming to cut the hassles of bailing out of a mortgage. One company promises that clients "will be able to live in [the] home for up to eight months with no mortgage payments," after paying $895 for a customized plan. The same site says it will provide clients with "legal credit repair" to "improve your FICO scores."
Another Web site claims that "your credit can be repaired and [you will] be able to purchase a house in as few as two years" -- after paying a $495 fee. Still another company says walkaways can expect "up to one year living payment free" as the lender goes about filing for foreclosure. That company charges $995 for its how-to-do-it kit.
Fair Isaac, developer of the FICO scores used in most mortgage transactions, is unhappy at any suggestion that a foreclosure could be minimized or wiped away in a short period of time. Its scoring model counts foreclosure as a long-standing and severe event, nearly comparable to bankruptcy, with negative consequences for all forms of credit that walkaways might seek to obtain. That includes credit card applications, auto loans, student loans, and even insurance and employment.
Craig Watts, a FICO spokesman, said that the impact of a foreclosure on a credit score depends heavily on the person's payment history and the length of and number of credit tradelines in the file, but "it is always significant."
Robin Stout Migala, consumer outreach manager for Freddie Mac, said in an interview that "there are so many bad reasons for walking away" from a home loan. Borrowers' credit standings get wrecked, forcing them into excessively high interest rates on any credit they can manage to obtain. They can face other problems, including federal income tax liabilities.
Federal legislation enacted last year allows homeowners who negotiate loan modifications with lenders and have portions of their principal debt eliminated to escape income tax liability for the amount forgiven. Walkaway borrowers, by contrast, have nothing forgiven, and the Internal Revenue Service may demand taxes on the balance they never paid, according to Migala.
Many borrowers facing foreclosure today have endured serious financial crises -- such as loss of employment, loss of an income-earning spouse, medical issues or predatory loan terms -- that led to their inability to make their mortgage payments, said Migala.
When they apply for a loan from either Freddie Mac or Fannie Mae, she said, the standard application form asks whether they have ever experienced a foreclosure or handed over their deed in lieu of foreclosure.
If applicants check "yes," the loan is immediately shifted to manual underwriting. Every piece of information is scrutinized by underwriters, who probe for the facts surrounding the loss of the house.
For borrowers who faced genuine financial hardships leading to foreclosure, underwriters are likely to be more sympathetic a few years down the road. But if you walk away, here's the deal: Don't expect to get a new home loan -- certainly not one with favorable terms -- for five to seven years.
That's no matter what some promoter online promised you.
Kenneth R. Harney's e-mail address is KenHarney@earthlink.net.