You’re underwater on your mortgage, should you try a short sale of your home or should you walk away in a strategic default and risk a deficiency judgment?
Q: My daughter is in an interest-only loan with a 30-year term. Her interest rate is 8 percent. She owes $128,000 on the loan. Fannie Mae owns the loan.
She has tried to refinance her home. We thought that she could refinance her loan under the Making Home Affordable Plan, but was told she makes too much money to get help.
What would happen to her if she walks away from the home and what are the penalties? Can she be sued for the principal and can they garnish her wages? She has a good job and if her wages were garnished, she would lose her employment. She is a single mom with a 10-year old son with no outside help.
A: Your daughter does have a high interest rate on her loan based on where interest rates are today. But her loan is an interest-only loan which means that her monthly payments are much lower than they otherwise would have been. Did your daughter take out an interest-only loan to lower her monthly payments so that she could afford to buy the home?
You didn’t mention that your daughter can’t afford to make the payments. You seem to be asking what she can do to find a lender who would be willing to refinance her mortgage.
Is she having a problem with the equity in her property? If the value of her home has dropped, she may not have enough equity to do a refinance. Most lenders will only allow her to borrow 80 percent of the home’s value. So if her old loan is greater than what her home is now worth, a lender won’t give her enough money in a refinancing to pay off the old debt.
You might want to wait and see if your daughter can benefit from the recent changes that are being made to the Home Affordable Refinance Plan (known as HARP 2.0). It is designed for homeowners who want to refinance but whose homes are worth less than the mortgage balance. It may be that the HARP 2.0 guidelines will allow her to refinance her home. (Get more information on the program at MakingHomeAffordable.gov.)
If your daughter walks away from the home, she runs the risk that the lender will pursue her for any money owed on the loan. While in some states there are laws that prevent deficiency judgments against borrowers, many states allow them.
If the lender does not get fully paid off, the lender can take an additional step after the foreclosure and ask a judge to issue a judgment for that difference, a deficiency judgment. A borrower then runs the risk that the lender might pursue him or her to garnish the borrower’s wages or find assets the borrower might have that could satisfy what is owed. That’s what your daughter fears most because she could lose her job.
So far, most lenders have not pursued borrowers after a home is foreclosed. But in some states, lenders can still obtain a deficiency judgment years after the foreclosure. But if the lender does obtain the deficiency judgment, not only can the lender take action against the borrower, the lender can sell that deficiency judgment to a bill collector and that collection company can pursue the borrower.
You would have to determine whether your daughter’s state permits deficiency judgments. If it does, your daughter would be better off trying to sell the home, even if she sells the home in a short sale. If she goes the short sale route she would have a better chance of having the lender agree to the short sale and waive any right to pursue a deficiency against her.
Whether your daughter decides to walk away from the house or pursues a short sale of the home, her credit score and credit history would suffer.
According to FICO, a major player in the credit score industry, a borrower who is 30 days late on his or her mortgage will see a drop of 60 to 100 points in his or her credit score. If the delinquency goes to 60 or 90 days, there are additional drops in the credit score. And, if you go the short sale route, you might see an additional drop on your credit score especially if there is a deficiency reported on the sale.
If your daughter has a credit score of about 720 and she walks away from the home, she should expect a drop in her credit score to about 570, but if she goes the short sale route, her credit score could drop by the same amount depending on the deficiency.
But let’s hope there is a refinance in your daughter’s future so she can afford to stay in her home. What she needs to do now is talk to a good mortgage lender or mortgage broker to evaluate her options.