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Beware Walking Away from a Devalued Home

by Douglas Lineberry on February 3, 2010

So your home or condo has lost a lot of value? Maybe it’s lost so much value that you just don’t see the point any more and you are considering walking away and turning it over to the bank. Beware that in so doing you may get to keep paying a debt for a home you no longer own.

The New York Times reported on the growing number of people that walk away from underwater homes (underwater generally meaning any home with debts that exceed value). You can find the article here. The short version is that an many people with the ability to keep on paying their mortgages are abandoning underwater homes anyway, apparently not seeing that it makes any sense to keep paying for something that will take perhaps decades to recover its value (if ever).

The article misses a crucial asset protection point. The bank may not be happy with just taking the home and dinging your credit. Loans typically have two documents underlying them. The homeowners personal promise to pay the debt is the promissory note. The promise is secured by a security instrument (often a deed of trust). If the homeowner doesn’t pay on the note the security instrument gives the bank the right to foreclose. Upon foreclosure and eventually the sale of the property, the sale proceeds are applied toward the promissory note debt.

The significant point missed in the article is that the bank doesn’t necessarily take whatever it gets out of the foreclosure sale in full satisfaction of the promissory note. At the outset of the foreclosure process the bank will assess what it is likely to get at a foreclosure sale. If the bank believes that it will get something less (or perhaps “much less”) than the full amount due then the bank can take steps to get the deficiency from the homeowner.

How does the bank do that? In some states (including Washington), the bank’s security instrument is often a deed of trust. A deed of trust typically includes a provision that allows the trustee to foreclose non-judically and sell the property at a trustee’s sale. If the bank uses this non-judicial foreclosure alternative then the bank is often not allowed to get a deficiency judgment. (NOTE: I say “often not allowed” because I’m trying to be general. Non-judicial foreclosure does mean that the bank can’t get a deficiency judgment in Washington but I’m not going to address every state out there – you need to look into the result in your own state.) However, the bank is not required to use the non-judicial alternative and can instead elect to judicially foreclose upon the security and then get its deficiency judgment.

So what’s the risk to the walk-away strategy? If you’re thinking about walking away because of decline in value but you do have the capacity to keep paying, you ought to expect that the bank is going to elect to foreclose judicially and get the deficiency judgment against you. You will have rid yourself of the home, but if the bank doesn’t get the full amount of the note out of the foreclosure process you will get to keep paying until the deficiency judgment is satisfied.

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