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Just Walk Away...From Your Underwater Mortgage
If you are severely underwater on your mortgage, what can you do? Should you walk away?
September 04, 2011 /Law Enforcement PR News/ -- In the last few years, the real estate market has taken the greatest downturn since the Great Depression of the 1930s. Home values have plummeted, homeowner's equity has evaporated, and thousands have found themselves underwater, owing much more on their mortgage than their house is now worth.
The market is still saturated with foreclosed homes, and some markets the price of homes still may not have bottomed out.
Some homeowners are underwater so far that they may not live long enough in the house for it to recover enough value to allow them to break even. Moreover, banks continue to be slow in offering loan modifications.
Walk?
The situation is so dire that some homeowners, after reviewing their overall financial health, decide drastic action is their only option. Their conclusion? Walk away from their home and their mortgage and allow the bank to foreclose.
This is usually accompanied by their filing for bankruptcy, to discharge the remaining personal debt. While drastic, this may be in the best interest of the homeowner.
Risk Of Loss and Why Banks Won't Modify Loans
If you remain in a house with a seriously underwater mortgage, it is you, the homeowner, who carry the risk of loss for the bank. One reason banks are so unwilling to modify mortgages is profit.
In Whose Interest?
As long as a borrower is making payments, it is not in the bank's financial interest to reduce the value of their mortgage. Offering to modify a loan for a borrower who can pay only encourages other borrowers to also request their loans be modified and this further erodes the bank's profits.
In addition, there is the self-interest of the managers in the distressed assets department of the bank. They are unlikely to receive a bonus for liquidating the largest number of assets and taking the greatest write-down in their department.
If your mortgage is 25 percent underwater, the bank is essentially hoping you don't notice, keep making payments and allow them to reap the 25 percent profit above the real value of the property. They want you to bear the risk for that 25 percent for the next 20 years that it will take for your house to recover that value.
Do you really want to carry that burden?
If you do walk away from your mortgage, how do you buy somewhere to live? The answer may be your 401k.
401k Hardship Withdrawal
To remove all of your 401k savings, you need to obtain what is known as a hardship withdrawal.
For most people, a 401k hardship withdrawal can be done, but there are fees, taxes and possibly tax penalties that may apply if you are 59 years old or younger. The fear when you do this is the elimination of your 401k retirement savings and that you may not have enough working years available to rebuild it. Another downside is the fees and taxes can add up.
Some financial experts may advise that cashing out a 401k plan for a home purchase can be an economically sensible, if there is enough of a balance to pay the purchase price of the home.
Many 401k balances individuals in their 40s or 50s may have a sufficient account balance to cover most if not all of the price of a modest home, with a cost of roughly one hundred thousand dollars.
This may be more possible, as the decline in home prices that has forced some to consider walking away from their mortgage, may also have driven prices low enough to make a modest 401k balance adequate to cover the purchase price.
IRS Tax Rules
For the IRS, a distribution is made "on account of hardship" only if it is made both on account of an immediate and heavy financial need and is necessary to satisfy financial need.
The determination of the existence of an immediate and heavy financial need and of the amount necessary to meet the need must be made in accordance with standards in the 401k plan.
Immediate And Heavy Financial Need
Whether you have "an immediate and heavy financial need" is to be determined based on all relevant facts and circumstances.
A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred.
Some of the circumstances that the IRS considers an immediate and heavy financial need:
- Expenses for medical care previously incurred by the employee, the employee's spouse, or any dependents of the employee or necessary for these persons to obtain medical care;
- Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);
- Payment of tuition, related educational fees, and room and board expenses, for the next 12 months of postsecondary education for the employee, or the employee's spouse, children, or dependents;
- Payments necessary to prevent the eviction of the employee from the employee's principal residence or foreclosure on the mortgage on that residence;
- Funeral expenses; or
- Certain expenses relating to the repair of damage to the employee's principal residence.
Not An Easy Decision
The choice? A house to live in or your retirement savings. There are no easy answers to this choice. For some people, if they have enough in their 401k, having the security of a paid off home, may be the better choice than leaving money in a volatile stock market, where, as we have seen too many times in recent years, a lifetime of savings can be wiped out in a weekend.
Article provided by Barrett Law, PLLC
Visit us at www.bankruptlansing.com
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