Is Foreclosure for You?

Hyacinth O'Meally recalls the thrill she felt, less than two years ago, when she bought a two-bedroom, two-bath condo in Pembroke Pines, Fla. But as December approaches, she hasn't made her November mortgage payment yet—and she's searching for a way out. "I am thinking about walking away," she told me last week. "Would I be liable for the taxes and the balance of the mortgage? What would you do? Would you ride it out or walk away?"

Handing the keys back to the bank is a process nobody talked about during the housing boom, when we were all too busy choosing granite countertops and watching "Flip This House." But with the fallout from the subprime mortgage mess spreading, lenders say thousands of homeowners are looking for options. In O'Meally's case, she's considering a "deed in lieu of foreclosure," in which a distressed homeowner signs a property over to the bank to avoid a full-blown foreclosure. In certain circumstances, doing a "deed in lieu" can be win-win: the bank avoids the legal hassles of foreclosure, and the borrower's credit rating takes a smaller hit.

O'Meally, 61, bought her Florida condo in February 2006 for $228,000. She put down 10 percent of the purchase price. Due to various fees (the details of which remain murky), she paid $41,000 before closing. She ended up with an adjustable-rate subprime loan with an interest rate of 9.5 percent and a monthly payment of $1,669. Ouch. If those high closing costs weren't enough, O'Meally received a second surprise soon after the closing. She assumed her monthly nut of $1,669 included escrowed payments for property taxes and homeowners insurance. It didn't. Soon she was looking at property tax bills of approximately $4,000 per year on top of her mortgage. It was too much for her budget, she says.

Her situation grew worse last fall, when she was laid off from her $50,000-a-year job as a payroll administrator. She found a new one, but at a lower salary. By 2007 her monthly take-home pay had settled around $2,600 per month—and her mortgage, taxes and insurance ran more than $2,000, she says.

For the last year she has dipped into savings to pay her mortgage. But several months ago, with her rainy day fund depleted, she called the bank. After she sent in pay stubs and tax records, her loan servicer, Chase (which was not involved when she bought the property), agreed to modify her loan, adjusting her interest rate downward to 5 percent until 2009. At first, O'Meally was thrilled with her new $1,114 monthly payment. But this month Chase began including her property tax payment in with the loan—which bumped the monthly payment back up to nearly $1,700. With no savings to supplement her income, O'Meally says she can't do it. "I don't even have $10 in the bank now," she says.

Should she walk away—and would the lender allow it? I ran that question by several lenders and housing counselors. While her circumstances are unique, their advice applies to anyone who's in serious mortgage distress. Here's a rundown: