Voluntary Foreclosure under Arizona Law
Arizona's housing market has been hit hard. But despite the financial ability of some homeowners, many are choosing to voluntarily walk away or "strategically default" on their mortgages.

October 21, 2010 /24-7PressRelease/ -- Arizona has been hit hard by the housing market crisis. In 2009, Phoenix, Mesa and Scottsdale shared the dubious honor of having the eighth highest rates of foreclosure in the country. Roughly 8 percent of households in these cities received a foreclosure notice.

However, not all of these foreclosures are attributable to homeowners who simply can no longer afford to stay in their homes. With an estimated one in four mortgages underwater, some homeowners are making a strategic decision to stop paying their mortgages. Known as "strategic default" or "voluntary foreclosure," homeowners who willingly walk away from their houses do so not because they can no longer pay the mortgage but because it makes financial sense to let the house go.

Many commentators sharply criticize homeowners who voluntarily decide to walk away; accusing them of making an unethical choice and blaming them for making the housing crisis worse. They argue that homeowners have a duty to fulfill the conditions of the mortgage agreement just like any other binding contract.

However, others argue, homeowners choosing to strategically default are acting no differently than businesses who decide it is better to "efficiently breach" or let a bad loan go than to continue to pay for it. Many businesses commit an efficient breach when the consequences of the breach are less harmful to the business than fulfilling the terms of the contract.

Much like businesses, however, homeowners considering voluntary foreclosure must be aware of what the potential risks are before they stop making their monthly mortgage payments. Fortunately for Arizona homeowners, state law limits the type of actions banks and other lenders can take to recoup their losses from a foreclosed property.

Arizona's Non-Deficiency Law

In some states, "recourse laws" are in place. If a homeowner voluntarily walks away from his or her mortgage, lenders have the right to obtain a judgment against that homeowner's other assets to recoup the losses from the foreclosure. When there is a difference between the amount owed on the mortgage and the amount the lender recovers when it sells the foreclosed property, the lender can go after the homeowner's other property including bank accounts.

However, 11 states - including Arizona - are non-recourse states and limit the rights of lenders to go after a homeowner's other assets to satisfy a mortgage debt. In these states, generally speaking, the house is the only property lenders are permitted to take from a homeowner who has defaulted on his or her mortgage.

Specifically, Arizona has "non-deficiency" statutes in place that protect homeowners from default judgments by lenders. The following conditions must be met to qualify for protection under these important laws
- The property must be a single or two-family residence
- The property must be on two and a half acres of land or less
- The property must be occasionally occupied, either by the homeowner or renters

Additionally, the non-deficiency statutes only apply to "purchase money loans," i.e. money used to purchase the house, not money taken out of the home to pay other bills or purchase other items.

Also, the law negates any protection to homeowners who meet the above requirements if "waste" has occurred. If the homeowner has allowed the property to fall into disrepair and as a result, the property's value has diminished, the lender can bring an action to recoup this loss against the homeowner for waste.

In cases where properties do not qualify for protection under Arizona's non-deficiency statute, the lender may seek a deficiency judgment against the homeowner for the difference in price between the mortgage balance and sale price. However, to do so, the lender must bring a judicial foreclosure action rather than a trustee action. Judicial foreclosure actions generally are longer and more expensive. For this reason, most lenders will not pursue judicial foreclosure actions unless they know they can recover enough money from the homeowner to make it worth their time.

Other Consequences of Foreclosure

While Arizona homeowners considering strategic default may feel relieved to find out their lenders cannot go after assets other than their homes, they still must consider the other consequences of voluntary foreclosure. These consequences include:
- Lower credit score: when a homeowner stops making payments on their mortgage, this may show up as a negative mark on their credit report. Foreclosures stay on a credit report for seven years and credit scores may decline by 100 to 400 points. However, in Arizona, lenders are not allowed to report mortgage defaults to the credit bureaus.
- Difficulty buying another house: those looking to buy a home with a foreclosure on their record may find it difficult to do so - at least in the first few years after the foreclosure. Fannie Mae and Freddie Mac generally will not approve a mortgage within four years of a foreclosure. Due to the increase in strategic defaults, Fannie Mae recently announced it would not approve borrowers for home loans for seven years after a foreclosure.
- Tax liability: potential tax liability is another factor homeowners must consider before stopping payment on their mortgage. A foreclosure can result in cancellation of debt income, which is considered earned income for purposes of state and federal income taxes.

In a simplified example, if a $500,000 home forecloses and the bank recovers $350,000 in the sale, the lender is in essence forgiving the remaining $150,000 owed by the homeowner. This amount then is considered cancellation of debt income and is taxable. Federally, homeowners have been given a reprieve until the end of 2012 on paying these taxes under the Mortgage Forgiveness Debt Relief Act. However, this law only applies to federal taxes and not state taxes.

Further Discussion with an Attorney

Homeowners considering strategic default should speak with an experienced attorney before walking away from their mortgage. A lawyer can review the homeowner's specific circumstances and discuss the potential consequences of voluntary foreclosure, including potential tax liability. A knowledgeable attorney also can discuss other available options, such as bankruptcy or renegotiating the terms of the mortgage.

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