Walking Away Without Liability
Don't be fooled by people who say that you can just walk away from a mortgage. While that may be a great plan in non-recourse states like California, Illinois homeowners may want to think twice before moving out and mailing their housekeys to their lender.
With almost 50% of Chicago homes underwater, it makes sense to cut a bad investment loose. It also makes sense to protect yourself from a deficiency judgment. When a bank sells your home at a sheriff's sale, it probably won't get the home's full value. It used to be that there were very few deficiency judgments -- home prices kept going up, and those who were in foreclosure tended to have equity in their homes. These days, many homes are at risk.
The common knowledge is that lenders aren't seeking deficiency judgments, especially in Cook County. As regulations tighten up, expect lenders to exact revenge on homeowners by seeking those judgments. Simply abandoning your home or investment property is very likely to come back and bite you.
So how does a savvy homeowner cut a bad investment loose? After all, corporations do it all the time. There are three ways to gracefully exit your underwater property.
1. Deed in lieu of foreclosure: A deed in lieu of foreclosure is when a homeowner literally executes a deed in favor of the lender instead of going through the foreclosure process. In order to qualify, your property must only have one mortgage. Lenders won't offer a deed in lieu if there is a second mortgage, even if that second mortgage is issued by the same lender. Most lenders will require you to list the property for 90 days. They will also require financial information to verify that you have a financial hardship and that you are at risk of defaulting. The advantage to a deed in lieu is that the lender agrees to waive its right to pursue a deficiency judgment against you.
2. Consent foreclosure: A consent foreclosure is usually done after a lender sues you. You literally consent to a judgment of foreclosure and sale being entered against you. The upshot is that banks will accept a consent foreclosure even if there is a second mortgage against the property. A consent foreclosure also protects you from a deficiency judgment. If a foreclosure lawsuit has been filed against you, this may be a very efficient means of getting out from under a bad investment. Many people are determined to hang on to their homes. After a lawsuit is filed, many realize that a property with a loan to value ratio of 148% just isn't worth keeping. The consent foreclosure provides a set date by which you must vacate the home and protects you from any further liability.
3. Chapter 7 bankruptcy: A Chapter 7 bankruptcy severs all personal liability on your note. This does not mean that your home becomes foreclosure-proof. A mortgage loan binds both you and the property. The bankruptcy frees up your obligation, but the lien remains on the home. Like a consent foreclosure or a deed in lieu, this remedy will protect you from a deficiency judgment. However, even if you surrender the property during the bankruptcy, there is no guarantee that the bank will take the property via foreclosure. You may be on the hook for insurance, taxes, HoA/condo association assessments, and maintenance until the bank gets around to taking the property back.
The other option -- Chapter 13 lien-stripping: This option doesn't involve walking away. However, it can help some homeowners restore equity in their homes. If your second mortgage is entirely underwater, you can strip the mortgage lien and treat the balance due on the note as an unsecured debt. In some cases, you can pay back a fraction of the balance due via your Chapter 13 plan. Once you receive your discharge, the second mortgage is completely extinguished and you are no longer liable for the remainder of the loan's balance. This method can help some homeowners reach the break-even point on their home's equity. If you can afford to fund a Chapter 13 plan, and are determined to keep your home, this may be the best option for you.
As always, it is important to consult with a licensed Chicago consumer attorney before attempting any of these options.