Considering refinancing your mortgage? Now might be a good time since rates are low, but they could rise as the economy recovers. If you’re having trouble making your mortgage payments, you might be thinking about walking away. In some states, known as non-recourse states, you can do this without the bank seizing your other assets.
Imagine you owe more on your mortgage than your home is worth, and you don’t think the value will ever bounce back. This was a common scenario during the 2008-2009 financial crisis. Many homeowners stopped paying because banks wouldn’t let them refinance. This led to a surge in foreclosures, especially in non-recourse states like California, Arizona, and Nevada.
So, what are these non-recourse states? They are Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas (only for home equity loans), Utah, and Washington. If you own property in one of these states and have significant assets elsewhere, you can legally hand over your house keys to the bank and walk away from your mortgage without any penalties against your other assets.
Here’s an example. Let’s say you have a million dollars in the bank and bought a house for $800,000 a few years ago with a $750,000 mortgage. The real estate market crashes, and your home’s value drops to $400,000. You’ve already paid $50,000 of the mortgage principal. Now, $300,000 of your mortgage is unsecured, meaning your house is an under-secured debt. In a non-recourse state, if you hand over your house, the lender can’t collect the $500,000 unsecured debt. They took this risk when they approved your mortgage, and you can walk away with your million dollars and live happily ever after.
But what if you bought the house for $800,000 with a $300,000 mortgage, then took out a second mortgage worth $500,000, and the house’s value drops to $100,000? You can walk away from the first mortgage, but you’re still on the hook for the second one. Since you no longer have the house as collateral, the second mortgage is now an unsecured debt, which can be discharged in bankruptcy.
Speaking of bankruptcy, if you’re considering it, having a lot of cash on hand could be a problem. The court might say you have to pay back your second mortgage. But let’s be realistic, most people don’t have a million dollars lying around. More likely, you have $1,000.
If your income is above the median, you could qualify for a Chapter 13 bankruptcy. This doesn’t erase your debt, but it consolidates and restructures it into an affordable monthly payment plan over three to five years. If your income is below the median, you could qualify for a Chapter 7 bankruptcy, which liquidates and discharges all your debts, including the second mortgage. You can apply for a new FHA home loan two years after your bankruptcy is discharged.
Bankruptcy might be a good option if creditors are harassing you, you’re facing repossession or foreclosure, or you’re only making minimum payments on your credit cards. It can give you a fresh start if your finances are out of control. Most bankruptcies are caused by job loss, medical emergencies, or family emergencies. You might have been living within your means, but then you lost your job and missed a payment. Or maybe you or a loved one had a medical emergency that resulted in unmanageable bills.
Is it right or wrong to walk away from a mortgage if you can afford it? During the last financial crisis, many people in California who had substantial assets simply walked away from their mortgages because it made financial sense and was legal. Sure, their credit scores took a hit, but if they had other properties and didn’t need more credit, it didn’t matter to them.
Personally, I would never walk away from my debt obligations because it feels dishonorable. Even though I bought a vacation property that lost value during the crisis, I’ve continued to pay the mortgage every month. Those who walked away from their properties in 2008-2010 haven’t seen a rebound in net worth. Instead, they’ve fallen behind because the stock market and real estate market have recovered significantly since 2009-2010.
If you’re going to buy property, hold onto it for the long term. Transaction costs are high, and selling during downturns can wipe out your equity and potentially set you back for life.
Property demand is soaring because mortgage rates are at record lows, and people want to own nicer homes and real assets. So, if you’re looking to buy property, it might be a good idea to do so before herd immunity is achieved. Real estate demand in non-recourse states like Texas and Washington is very high, and these states don’t have state income taxes.
The situation now is not like 2008-2009 when homebuyers were overextended. Banks have been stricter since the last financial crisis. Today, the average credit score for an approved mortgage borrower is 770. Homebuyers are also following good home-buying rules and building up equity in the housing market.
Even if you live in a non-recourse state, you should still run the numbers and make sure you can comfortably afford a home. Just because you can walk away from a property without as much consequence doesn’t mean you should.
If you’re considering refinancing your mortgage, check the latest rates online. You can get real quotes from pre-vetted, qualified lenders in under three minutes. The more quotes you get, the better. This way, you can make lenders compete for your business.
If you don’t have the down payment to buy a property, don’t want to deal with managing real estate, or don’t want to tie up your liquidity in physical real estate, consider real estate crowdsourcing. Fundrise and CrowdStreet are two of the largest real estate crowdsourcing companies today. They allow you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. I’ve personally invested $810,000 in 18 real estate crowdfunded projects across the Heartland and South. I love earning passive income and diversifying away from my expensive San Francisco holdings.
