When to Seek a Deed in Lieu of Foreclosure

Dear Debt Adviser,

My husband and I are struggling to make ends meet. We're retired and owe a lot more on our home than it is worth. The payments are too high for our fixed income, and we're trying to find the best way to handle this. As far as we can tell, we wouldn't be able to refinance the home at a lower interest rate since our debt-to-income ratio is too high. We are thinking instead of a deed in lieu of foreclosure, which I think would allow us to walk away from our mortgage. Our credit score will take a hit, but at this point in our lives, it doesn't matter. Do you think this would be our most beneficial route to take? Thank you for your advice.

-Peggy

Dear Peggy,

I'm concerned about the decision you and your husband have made to retire. Your inability to pay your mortgage should have been a warning sign that you weren't financially prepared to retire. Of course, many people are forced into retirement because of illness or other circumstances that prevent them from continuing to work. However, if you are physically able and willing to go back to work, I suggest that you strongly consider it.

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Besides your credit, you may have more to lose by walking away from your mortgage. For example, any debt forgiven on a mortgage will be considered income by the IRS following the 2013 expiration of the Mortgage Forgiveness Debt Relief Act. So you would owe income taxes on the amount forgiven with a deed in lieu of foreclosure. Depending on how much your home is underwater, you could be looking at a very big tax bill.

Additionally, you'll need to be sure that your financial problems will be solved by walking away from your house. If not, you're probably going to need to get a job. And it is much harder to get hired with a bad credit report since many employers use them as a part of the hiring process.

Finally, losing your house means you're going to need to find another place to live. Just like potential employers, many landlords check credit reports as part of the leasing process. And the foreclosure will be on your credit report for seven years.

So, bottom line, I'd suggest that before you do anything else, you should review your retirement plans with a financial professional. Meanwhile, update your resumes. And if you want to check out the real cost of your debt, check out one of Bankrate's debt management calculators.

Good luck!

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