In order to remove your name from a VA loan, you have several options: strategic default, short sale, foreclosure or bankruptcy.
Q: I’ve read about strategic default and bankruptcy, and I’m a bit confused as to which is the better option for me.
I have a VA loan on my house in Georgia, that I moved out of in 2008 due to a military PCS transfer. The house sat empty for nine months until I got a renter to move in it. But the renter finally moved out four months ago.
In that time, the property fell dramatically in value and it is now about half of what I owe. I didn’t try to sell due to the local real estate housing market being bad (and it still is).
I have a good, low interest rate and can afford to pay mortgage, but really, without a renter, I am just throwing cash away each month. I could be putting that money towards my children’s future each month.
No one seems to understand the VA portion of my loan. I’m not looking to make money. I just want to get my name off loan and try to preserve my credit. What are my options?
A: While you can afford to pay your mortgage, it’s clear that you no longer want to. That leaves you with several options: strategic default, short sale, foreclosure or bankruptcy.
A strategic default is where you basically turn the property over to the lender in exchange (hopefully) for full forgiveness of the debt. Because the property is not a primary residence, you will owe federal and state income tax on the deficiency, the difference between what you owe and how much the property brings at a foreclosure auction.
A short sale is where you sell the property for whatever you can get, which is typically less than what you owe. This is a more complicated process, since the bank has to approve the purchase price. Again, because this isn’t a primary residence, you would owe federal and state (if applicable) income taxes on the difference between what you owe and net amount to the bank after the sale is complete.
In a foreclosure, the bank takes back the property because you have stopped making any payments. These days, a bank might allow you (or in your case, your tenant) to stay for months or years before processing the foreclosure. It’s different for every state. Again, even if the bank releases you from the deficiency, the IRS will not and you will owe federal and possibly state income taxes on this amount.
Bankruptcy is the final option for those who need to restructure their debts. But it is difficult to file for bankruptcy as there are certain financial requirements. You must also go through a pre-filing bankruptcy counseling session and receive a certificate of completion. Once you file for bankruptcy (whether it is a Chapter 7 liquidation or a Chapter 13 reorganization), some of your debts may be wiped out while others are left for you to handle in a different way going forward.
Whichever of these four options you choose, your credit will be severely damaged. Of the four, a short sale will damage your credit the least, followed by a strategic default, foreclosure and then bankruptcy. If your property was your primary residence, and you chose one of these options and were able to close by the end of 2012, then the federal and state tax hit wouldn’t apply.
What should you do? That depends on what your top financial priority is going forward.
If you’re most worried about preserving your credit, then you should find a new renter and keep making on-time mortgage payments. If you’re worried about wasting money, then you should do a strategic default, where you turn over the property and the bank releases you from any deficiency you may have. Just be aware that you will trigger a taxable event, so consult with your tax preparer for more details.
Finally, if you go into foreclosure or do a strategic default with a VA loan, you will be unable to use your benefit again until the government (which backs VA loans) has been made whole. So, be sure this is what you want to do. Contact the VA toll-free at (877-827-3702) to discuss your situation with a VA financial counselor. The Veterans Administration home loan website is http://www.benefits.va.gov/homeloans/.