If you’re drowning in your mortgage and end up “underwater” on your home loan, can you just walk away from it? In the US, many American homeowners did just that after the housing crash in 2008.
But can that happen in Canada? Can homeowners simply walk away from their mortgages if their outstanding balances are higher than what their homes are actually worth?
Being over-mortgaged and facing negative equity in your home is a stressful and financially detrimental situation to be in. Many homeowners who find themselves in this situation may feel completely overwhelmed and helpless, potentially to the point that they may throw in the towel and simply walk away from their home and mortgage before even being forced into foreclosure or power of sale.
So, what can and can’t you do when you’re unable to pay off your entire mortgage after a sale or bank foreclosure?
Mortgage Shortfall
Being “underwater” on your mortgage means that the equity in your home or its market value is less than what you still owe on your mortgage. In other words, you owe more money to your lender than what your home is actually worth, and your lender could be left with a mortgage shortfall.
Let’s say your home is currently worth $400,000, but you owe $450,000 on your mortgage. In this case, since your home is worth less than what you still owe, you’re considered to be underwater.
How can this happen? How can you owe more money than what your home is actually worth?
A couple of things can happen that may cause you to have less equity in your home than what your outstanding balance is. For instance, perhaps property values have plummeted since you first bought your home. Maybe the home was once worth $500,000 and is now worth $100,000 less.
Or, you could have taken out a loan against your home, in which case you borrowed against the equity in your home and now owe more than what you may have started out owing when you first took out your mortgage.
Either way, it’s possible to wind up having negative equity in your home. In this case, your lender would be left with a mortgage shortfall that the mortgage default insurance provider would have to cover.
What Does ‘Full Recourse’ Mean?
If you’re underwater on your mortgage you may have considered selling in order to cut your losses and avoid getting even deeper into trouble. But you don’t necessarily have to sell.
If you’re able to keep up with your mortgage payments, you may be able to wait it out until the market turns around, in which case your home’s value could increase. With a boost in property value, even if your loan amount outstanding remained the same, you could end up breaking even and eventually owe less than what your home will be worth in the future.
On the other hand, if you can’t keep up with your mortgage payments and wind up in default, your lender can start taking steps to enforce a power of sale.
If you sell your home with a mortgage shortfall or you end up in foreclosure, you will still owe your lender the difference between the outstanding balance on your mortgage and the proceeds of the sale. If you sell for less than the loan amount you took out and are unable to pay the shortfall in full, your lender may be eligible to come after you for the difference.
This is referred to as “full recourse.” In this case, your lender has the legal right to pursue you for any monies still owed if your mortgage is underwater and you sell your home.
Can I Walk Away From My Mortgage in Canada?
In most provinces across Canada, “no recourse” mortgages don’t exist. Instead, “full recourse” legislation is in place that allows lenders to require borrowers to deal with their underwater mortgages rather than allowing them to walk away from them. As such, mortgage shortfalls end up becoming unsecured debt once the sale of the home is finalized.
Borrowers will still owe the outstanding amount, whether it’s to the lender or the mortgage default insurance company. That said, homeowners may walk away from their home loans if they file a consumer proposal or bankruptcy.
What Effect Does a Strategic Default Have on Your Credit?
Any information that the major credit bureaus are privy to will show up on your credit report and affect your credit score. These days, credit bureaus have access to information on mortgages, which means any strategic defaults will be noted on your report and pull your credit score down.
In this case, a strategic mortgage default will remain on your credit report for up to seven years. As such, it’s important for homeowners to think twice about simply trying to abandon their mortgage. Not only will this affect their credit report, but it will open up the floodgates for litigation by mortgage lenders.
Final Thoughts
It may be tempting to just wave the white flag and give up on your mortgage when you’re underwater and are facing a power of sale or foreclosure. While any one of these situations may be imminent, it’s important to understand what the laws in your province are surrounding this issue.
If you’re having trouble keeping up with your mortgage payments, it’s in your best interest to seek professional help, whether that’s from your mortgage lender or a credit counsellor, before your situation escalates.
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