A few years back, when housing prices were rising at double-digit rates and would-be buyers were like ants at a picnic, the very idea of walking away from a mortgage seemed ludicrous.
In 1990, however, the tables have turned: Housing prices have fallen in some parts of the country, and prospective buyers are about as scarce as tourists in Kuwait.
In fact, home prices fell during last year's third quarter in 26 of 96 regions tracked by the National Association of Realtors, the trade group recently reported. And the Mortgage Bankers Association of America said the number of delinquent mortgages rose sharply in the third quarter.
Now, the notion of stopping payments on home loans and letting lenders foreclose no longer may seem ridiculous to some homeowners. In fact, experts worry that the real estate slump and the sluggish U.S. economy may force more owners to turn in their house keys.
This is especially true in regions where home prices have dipped sharply. A decline of 15 percent, for example -- a realistic figure in some areas -- may be enough to erase an owner's equity, leaving a mortgage balance that is greater than the value of the house.
But giving your house back to the bank is not the best way out, experts said. Not only can the lender come after you for losses it may incur, but Uncle Sam also may be waiting.
Here's why. When a prospective buyer goes to settlement, he or she is required to sign both a mortgage and a loan note. The mortgage gives the lender first lien on the home. The note, however, gives the lender the right to sue for other personal assets.
"What a lot of people don't realize is that while the mortgage gives a bank collateral if you default on the loan, the note makes you personally liable for the amount due," said John B. Stine II, a tax partner at Price Waterhouse in Philadelphia.
Suppose that a person with a $90,000 mortgage walked away from the loan. If the bank were forced to sell the house for $80,000, the bank could sue the owner to recoup the $10,000 it lost. In fact, the owner could be liable for foreclosure costs, too. "I don't think it is a common practice, but I think it's happening more now than it did, say, five years ago," said Brian Chappelle, a vice president at the Mortgage Bankers Association. "Frequently, if a person loses his home, there is not a lot left to go after."
Lenders are more likely to go after personal assets if the owner can afford to pay the mortgage but elects not to, Chappelle said. In most cases, he said, banks will consider legitimate hardships.
The IRS, however, may be less forgiving. The laws that govern home mortgages are hard and fast:
Losses are not tax-deductible. So if the value of your house falls, don't cry to Uncle Sam.
Income from your house is taxable, whether it be income from appreciation or from a foreclosure. (Yes, foreclosures can, and often do, result in income for the homeowner.)
Here's how income comes into play:
Suppose you have a $90,000 mortgage on a $100,000 home, and its value drops to $80,000 before you decide to walk away. The bank then sells the house for $80,000 and does not come after you for the $10,000 balance. That $10,000 would constitute "forgiveness of debt." In other words, it would be income subject to federal tax.
People who have refinanced their homes for more than they are worth could be subject to double hits if they go into foreclosure, experts said. Suppose you had bought a house a few years back for $100,000. The house increased in value to $150,000, so you refinanced for $130,000. In recent years, however, the house has declined in value and you have walked away from the mortgages.
The bank has sold the house for $120,000 and has not come after you for the balance owed. That $10,000 would constitute forgiveness of debt, but that's not all. The tax basis of your house still would be $100,000, because that's what you paid for it. However, the bank will have sold it for $120,000, and that $20,000 difference is a taxable gain for you.
A person who cannot meet mortgage payments might be better off filing for bankruptcy, Stine said, although such drastic action should be weighed carefully.
Either way, the homeowner's credit rating would be ruined for several years -- 10 years in the case of bankruptcy and seven years in a foreclosure. But with bankruptcy, the owner could avoid additional taxes and the bank could not take other personal assets.