These days, it’s becoming a common situation for homeowners to have upside-down or underwater mortgages. This situation happens when the home value drops below the outstanding mortgage balance. More and more, home owners in this situation are simply walking away from their mortgages – and their homes – rather than holding onto something they can’t afford.
There are different degrees of strategic default. Some homeowners hold on to their mortgages for as long as they possibly can before they finally let go. Others call it quits early, before they’ve exhausted savings and retirement on what could become a hopeless situation. And there are borrowers who walk away from mortgages they can afford to repay, but choose not to put money into a losing investment.
Not Off the Hook
Walking away from a mortgage loan doesn’t let you off the hook for the mortgage. You’re still responsible for making the mortgage payments until the lender cancels the debt. Every month your mortgage goes past due, you’re a month closer to foreclosure. The late mortgage payment goes on your credit report and your credit score is affected.
After a foreclosure, you’ll be unable to get a new mortgage for three to five years and the foreclosure entry will stay on your credit report for up to seven years.
If the proceeds from your home sale don’t pay off your mortgage, the lender can go through the court to get a deficiency judgment for the remaining balance. You’ll still be responsible for paying that judgment, even though you no longer live in the home, unless the lender cancels it or you get it discharged in bankruptcy.
Mortgage Industry Response
Lenders may participate in a program to keep borrowers from walking away from their mortgages. The Responsible Homeowner Reward, pays homeowners who stay current on their mortgage payments. The catch, though, is that the reward can’t be cashed in until the mortgage is completely paid off. When you’re struggling right now, will you really wait 15 or 20 years to get that reward? Even if it’s as much as 10% of your loan balance?
The FHA, on the other hand, may penalize homeowners who strategically default on their mortgages. If you walk away from a mortgage that you could have paid simply because your home value declined, you may have trouble getting an FHA-backed mortgage for up to seven years in the future.
Alternatives to Walking Away
It’s possible that homeowners who choose strategic default have already exhausted their options. Alternatives include refinance, loan modification, selling the home, short sale, or deed-in-lieu of foreclosure.
In a struggling economy, many of these alternatives are out of reach either because the lender isn’t willing to work with the homeowner or because selling the home wouldn’t put the borrower in a better position.
Strategic default is not without consequences for everyone involved. The homeowner’s credit suffers and the lender loses money. Unfortunately, for some, it’s the only option available when home values decline far below the mortgage securing the property.
