The San Francisco Chronicle is reporting Fannie warns homeowners who walk away.



The country's two largest sources of mortgage money have a blunt warning for anyone thinking about joining the growing "walkaway" trend, where 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 (FNM) sent out new guidelines to lenders intended for walkaways and other foreclosure situations. Fannie will now prohibit foreclosed borrowers from getting another mortgage through the giant investor for five years, unless there are "documented extenuating circumstances." In those cases, the mortgage prohibition is for three years.



Freddie Mac (FRE), Fannie's rival, 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.

My Comment

(1) Just because a state permits recourse loans doesn't mean it forbids non-recourse loans! In general, parties to loan transactions are allowed to agree on whatever terms they are able to negotiate. It's a freedom-to-contract principle.



(2) However, just because a document is stamped "Non-Recourse" doesn't necessarily make it such. A stamp on a document may be part of its terms, or it may be legally meaningless. To be sure the loan is truly non-recourse, I would suggest reading the entire document pretty carefully.

The walkaway trend is particularly noteworthy in former housing boom markets - including California, Florida and Nevada - 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.

My Comment

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. Not only are borrowers' credit standings wrecked - forcing them into excessively high interest rates on any credit they can manage to obtain. But they also face other potential 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 IRS may demand income taxes on the balance they never paid, according to Migala.

My Comment

If part of the forgiven debt doesn't qualify for exclusion from income under this provision, is it possible that it may qualify for exclusion under a different provision?



Yes. The forgiven debt may qualify under the "insolvency" exclusion. Normally, a taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is insolvent. A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness. If you believe you qualify for any of these exceptions, see the instructions for Form 982.

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 promised you online.

My Comment

California Attorney Chimes In

As a California real estate attorney I can tell you this:



1) Mortgage debt, whether its a first or second loan, is nonrecourse if it is "purchase money", used initially to purchase the property;



2) Mortgage debt that exists due to a refinancing and/or to second loan taken out after purchase is recourse, but -- and its a BIG but -- only if the lender elects to file a lawsuit for judicial foreclosure rather than going through the usual foreclosure process;



3) Suits for judicial foreclosure are in my experience of 28 years extremely rare, due mostly to the fact that any buyer at a judicial foreclosure sale has to give the foreclosed-upon party a full year to redeem the property. This of course is a complete deal-killer.



An interesting side-note: California's anti-deficiency law originated during the Depression years, in order to place the burden of properly valuing real property and risk of loss on lenders (who presumably were more sophisticated and able to assess value) rather than buyers. Fast-forward to now, when it turns out that rampant greed prevented lenders from acting rationally in their own self interest. Now they are paying the price with walk-aways and "jingle mail".

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