Underwater Mortgages: Is Walking Away or Doing a Short Sale Your Best Option?

Underwater Mortgages-Is Walking Away or Doing a Short Sale Your Best Option-150x150After the recent housing market meltdown, many home owners have found themselves underwater on their mortgages. Being underwater means that they owe more on their homes than the homes are worth, making it difficult to keep making mortgage payments. Knowing that you are paying significantly more for your home than what the home is worth feels like throwing money away and the majority of home owners will probably choose to get rid of the home instead of making payments for several more years. Having to abandon the home that you have created memories in can be very unpleasant for the whole family, but it is probably a better choice than throwing money out the window.

The problem with being underwater is that you practically have two choices that will get you out of this situation: you can either walk away from your home, in which case the lender will foreclose on it, or sell it for less than it was originally worth at a short sale. Both of these options have serious consequences, and there is no way around them, but you probably want to know which one is the better choice, which one will create less problems for you than the other.

Differences Between Walking Away and Doing a Short Sale

Several parts of your financial life will have to suffer as a consequence of both walking away from a home and doing a short sale. The most affected will be your credit score, and this is where doing a short sale seems to beat walking away from a home and having it go into foreclosure. With a short sale, the lender hopes to recuperate most of the amount that you owe him, and to avoid going through the lengthy and expensive process of foreclosing. Here are two main differences between walking away from a home and doing a short sale, and how they will affect you.

  • Your credit score. Walking away from your home will result in foreclosure, which will have a large negative effect on your credit score. Foreclosures typically remain on a credit report for up to 7 years, making it next to impossible for you to take out another mortgage loan and buy a new home. Short sales will also be added to your credit report, but worded as “settled for less” or something similar. Lenders prefer to recover some of the debt by doing a short sale instead of foreclosure, which takes a long time and is expensive. Your credit score has less to suffer when doing a short sale and it will be easier to recover, in only a couple of years.
  • Your ability to buy a new home. When walking away from your home, you can buy a new home after 5 years have passed, but with several restrictions, like making a larger down payment and paying a larger interest rate. After 7 years, the black spot on your credit report goes away and you are able to buy a new home without these restrictions, as long as everything else is in order. You can buy a new home right away after doing a short sale, as long as you haven’t missed any payments on your previous mortgage and the lender doesn’t require that you pay back the remaining amount. However, finding a lender that will give you a mortgage loan in this situation is very difficult.

Doing a short sale seems to be the better choice between the two, but there are many factors to take into consideration before you can decide. However, your credit score is probably the most important factor, so choosing to do a short sale over walking away from your home is probably the best option in most situations.

Walking Away from Your Mortgage: The Consequences

Walking Away from Your Mortgage- The Consequences- 150x150Financial 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.