Real Estate: Choosing Foreclosure

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:

Call Early, Call Often Lots of troubled borrowers hide from their problems instead of being proactive. In contrast, O'Meally asked for a modification, and the pros give her credit for doing that. Give some credit to Chase, too, for cutting her interest rate nearly in half. It's an example of why it pays to be proactive. "Whenever a borrower has a problem, they should call," says Chase media relations staffer Tom Kelly. Chase has already modified 17 percent of its subprime ARMs that were due to reset in the next nine months, suggesting some degree of flexibility.

Revisit That Closing Every professional who looked at the numbers guesses that O'Meally got fleeced by someone—perhaps a mortgage broker—when she took out her loan. "It sounds likely she was really ripped off terribly at the beginning," says Ray Hooper, education and housing director at the Consumer Credit Counseling Service of Dallas. What can she do about it now? The Department of Housing and Urban Development offers forms for homeowners to file a predatory lending complaint without an attorney. While this won't solve her immediate problems, it might eventually help her get back some of the upfront cash she put into the condo.

Examine Your Budget Housing counselors aren't just interested in your mortgage. They also want to look at car loans, credit card debt, cell phone and cable bills. By cutting back in other areas, they figure, you might find a way to make your mortgage. Some counselors may suggest taking on a second job or finding a roommate to pay rent. "The best-case scenario is you're able to increase your income by $500 a month, you get back on track, and everybody is happy," says Josh Fuhrman, director of counseling at the ++Homeownership Preservation Foundation. While O'Meally sees no hope of this, Chase says that before it modifies a loan like hers it typically scrutinizes a borrower's finances to ensure that she's able to make her new payments. Says Kelly, the Chase spokesman, "We'll only do a modification if we think it's going to work for the longer term." So there may be wrinkle in her financial picture a pro can see that she can't.

Walking Away Isn't Easy O'Meally has already talked with three real-estate agents about doing a "short sale," in which the lender agrees to allow someone to buy the property for less than the outstanding mortgage, waiving the shortfall. The realtors were unenthusiastic; the glut of nearby listings would make it hard to sell, they said, and they were worried about who would pay their commission. It doesn't help that O'Meally estimates that her home is now worth $175,000, more than $50,000 less than she paid for it. Even if a buyer did emerge, lenders caution that getting the green light on a short sale can take lots of time and paperwork.

That's also true for a "deed in lieu," in which the bank ends up owning the home. Unless the buyer is truly on the brink of foreclosure, the bank isn't likely to agree to this, the pros say. With O'Meally less than 30 days behind on her payments, she seems an unlikely candidate for this option—at least for now.

So what does RESIDENT EXPERT think O'Meally should do? In this case I'm going to defer to a housing counselor. She can find one by calling 888-995-HOPE, which is the referral line for the Homeownership Preservation Foundation. They'll send her to a no-cost local counselor who will dissect her monthly budget in search of wiggle room. Together they can also decide whether it's worth filing a predatory lending complaint to try to recoup some of those closing fees.

On the menu of choices facing borrowers like O'Meally, none is very pleasant. But give her credit for trying to find a solution. Like many of life's problems, this one won't go away on its own.