Strategic Mortgage Default Considerations for Physicians

Many physicians have a substantial portion of their net worth invested in one or more personal residential properties and must be aware of the effect the economy has had on this investment and what it means for their overall financial picture.

In last week's article, we focused on the buying opportunity the current down market presents for those looking to buy a home. This week we examine the other side of the street, knowing how and if you can walk away from an underwater mortgage as a strategic financial move and as part of your asset protection plan.

Why Would I Walk Away?

In some communities home prices are down over 50 percent off their peak pricing, even in the most desirable luxury communities. This has left many of the clients we deal with, even if they can afford their mortgage payments, looking at a 20 year to 30 year debt cycle on a home that’s worth 50 percent of what they paid for it only five years ago.

Many doctors bought large luxury homes as part of their investment and retirement strategy, figuring they’d raise their families in a dream home that when sold would play a significant role in their retirement when the kids were gone and they were ready to downsize. Others purchased expensive homes in rapidly appreciating markets, especially in the Southwest, on five-year adjustable rate mortgages never dreaming they wouldn’t make a huge profit let alone be upside down by 50 percent or more. These buyers are now faced with trying to re-finance those huge loans that no bank will now re-finance.

In the best cases, the gap between the home’s current value and what is owed can be covered and refinanced at the “historically low rates” you keep hearing about. In the majority of others, the gap is so large that it calls for a mortgage note buy-down so large that it creates a hardship. Both of these groups should take a hard look at the business sense of continuing their present course of action.

Who Can Do This The Right Way?

I can’t stress this strongly enough: The laws of mortgage default and lender recourse are complex, onerous, and state-specific. Get professional help from an expert, preferably an attorney in your jurisdiction.

Be exceptionally wary of loan modification programs and promoters, especially those demanding upfront fees, which are so notorious for fraud that they are prohibited by law in some states. We had countless clients tell us of paying some debt settlement experts to get their rate adjusted and of being advised to, “Stop paying on the mortgage so the bank knows you are serious and then they’ll put you in a special program and the Obama Administration will…” Not a single one achieved the promised results and nearly all resulted in serious defaults, repossessions that the client was trying to avoid, and in the worst cases, deficiency judgments and additional losses and legal expenses. A dozen or so states currently have some variation of an anti-deficiency statute, where the home is itself sole collateral for the mortgage and they can’t come after you for the difference between what the bank sells it for and what you owe. This typically applies only to purchase money mortgages, not re-finances or cases where you have taken large amounts of equity out of the home in the form of a home equity line of credit (HELOC) or some similar device. In those cases, as well cases where you have commercial property, this does not apply.

When’s the Time to Do This?

If you think you fit one of the profiles above, NOW.

You can re-allocate payments you are making on a bad investment into a better one and perhaps even escape any tax consequences of the debt forgiveness on the old loan. The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). It’s also a buyer’s market and if you time everything right you may qualify to buy a comparable home for less money at lower rates. Doing this after a default may preclude you from the opportunity, so know exactly where you are going next and have the keys firmly in hand before you leap.

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