The fluctuating housing market can make purchasing a house a bit of a gamble. If you buy when prices are high and the value of your home goes down, most homeowners can just wait it out. Houses are long-term investments and eventually with time you know the market will rise again.
“If you bought at the market high and prices drop, you could be underwater on paper, which means you owe more than the home is worth. If you’re not planning to sell and you can meet your payments, you don’t lose,” says Scott Terrio, manager of consumer insolvency for debt relief experts Hoyes, Michalos & Associates. “It becomes a problem for someone who discovers they can’t carry the mortgage payment plus all their other debt, especially if they’ve lost a job, dealt with an illness or they’ve simply run out of credit.” In those instances, it may make fiscal sense for the homeowner to abandon their mortgage and walk away. The home goes into foreclosure — the home is turned over to the lender, who attempts to recover their investment by forcing the sale of the home and using the money to pay off most of the debt.
This happened frequently in the U.S. during the financial crash in 2008; lenders were forced to absorb the unrecovered debt. Could this happen in Canada? It’s not quite as simple here. “In Ontario and most other provinces, there are full recourse rules, which means you can’t walk away from your mortgage obligation without recourse from the lender, who can pursue mortgage shortfalls in court,” explains Terrio. However, homeowners can file a proposal or bankruptcy, which makes any shortfall unsecured (like other debt such as student loans, payday loans, car loans, line of credit and credit card debt). “Once a proposal or bankruptcy is filed, you can’t be sued for any shortfall, which is the difference between what you owe and what the lender can get for the house.”
What is the difference between filing a proposal and filing for bankruptcy? They’re both solutions to resolve debt and provide legal protection from creditors (for example, creditors stop wage garnishments). In bankruptcy, you surrender certain assets in exchange to discharge debt. When you file a proposal, you make an offer to settle debt for less than you owe.
“Proposals are filed more frequently with our clients now than bankruptcy,” explains Terrio. While you have to make a better offer to your creditor than what they would get if you filed bankruptcy, “it has less impact on your credit long-term and you can keep your belongings, which makes it a very realistic and favourable option for many.”