Financial strain from the recent economic crisis, an illness, a job loss, or even divorce can lead to foreclosure. Millions of Americans have lost their homes to foreclosure over the past few years, and it’s never a pleasant experience. Losing a home can be very discouraging, and even depressing. However, there are some who choose to walk away from a mortgage on their own, even when they are able to make the payments. This comes with some serious repercussions, but it’s sometimes a better choice than keep making mortgage payments.
When Does It Make Sense to Walk Away from Your Mortgage?
Even if some consider walking away from your mortgage morally wrong, making those large monthly payments after home prices have dropped significantly makes many home owners wonder if maybe they should just stop paying their mortgage. Their properties are worth much less than when they took out their mortgage loan, but monthly payments have remained the same.
Generally, home owners who are considering walking away from their mortgage, also known as strategic default, are people with a good credit score who can afford to keep making payments on their mortgage, but decide to stop from a business point of view. Their home becomes a bad investment, so walking away from their mortgage seems like a better choice. This choice, however, comes with a few negatives, which may outweigh the pros, depending on each individual’s financial situation.
Consequences of Walking Away From Your Mortgage
Strategic default may sound like a good idea, but there are some things to keep in mind before going down that route. Here are the most important consequences of walking away from your mortgage:
- Your credit score will drop significantly. Whether the foreclosure on your home is voluntary or not, your credit score will be deeply affected. The default will remain on your credit report for up to 7 years and will interfere with your chance of getting another mortgage loan, making it near impossible. An alternative to strategic default would be a short-sale, which won’t do as much damage to your credit score. Dealing with a low credit score can be difficult, as it might interfere with your ability to rent a home or to make other large expenditures that require credit checks.
- Your taxes will still be due. The Internal Revenue Service will view your unpaid debt as income and expect you to still pay taxes on it. Depending on when you defaulted, you may be covered by the Mortgage Forgiveness Debt Relief Act of 2007, which protects you from federal taxes after your strategic default. However, other taxes, such as state taxes, may still have to be paid.
- You could be liable for a deficiency judgment. When your home is foreclosed on, the amount owed will usually be larger than the foreclosure sale price. The difference between the two is called a deficiency and, depending on your state laws, your lender may sue you to recover that difference.
Planning ahead before deciding to walk away from your mortgage is essential if you don’t wish to encounter some serious problems in the future. Many people who choose to do a strategic default open high credit card accounts, or buy another home before letting go of their current home. Living with damaged credit will be hard, so taking some precautions before walking away from your mortgage will save you some trouble.
Walking away from your mortgage can have serious consequences, like destroying your credit score, not being able to obtain a new mortgage loan, or being sued by your lender. Before considering a strategic default, make sure that you are fully aware of how this will affect you and your financial situation. If you decide that this is your best option, then carefully plan ahead so you don’t encounter any major issues down the road.