Walking Away From a Mortgage

The mortgage crisis has left many homeowners in the difficult position of having a mortgage that’s worth more than the home it’s secured by. Being upside-down in a mortgage is an undesirable situation so much that many homeowners have decided to walk away rather than continuing to pay and receive no equity in return.

Strategic default is the term used to describe a situation where homeowners voluntarily walk away from their mortgage, especially one they can actually afford to pay. The logic is that it makes no sense to pay more for something than it’s worth.

People who strategically default have often exhausted the other options available to them. Income restrictions may keep them from getting a loan modification. Selling the home obviously isn’t an option since the sale price wouldn’t cover the outstanding mortgage. The lender may have rejected short sale offers, which actually have a similar impact to credit scores as a foreclosure.

Those who choose to default on their mortgage may feel relieved just by making a decision. But, deciding to not to pay doesn’t let you off the hook. There are serious consequences to strategic default – the same as any other foreclosure situation. Failing to make mortgage payments will destroy your credit rating. First comes the late payment notices on your credit report and when the process is over, the foreclosure is added to your credit report. Foreclosure is a serious delinquency and one of the worst things for your credit history.

The saga doesn’t end at foreclosure. In some states, the lender can sue for a deficiency judgment, which is the difference between what the house was auctioned for and the amount you owed on the mortgage. So, even walking away, you might not be completely off the hook for the loan.

Strategic default may even have tax repercussions. If the lender writes off any portion of the mortgage over $600, they may send you a 1099 for the cancelled debt. The Mortgage Forgiveness Debt Relief Act allows you to exclude certain cancelled mortgage debt from your taxable income, but there are extra forms to do this. A tax professional can walk you through the process.

The future is not bleak for strategic defaulters or anyone else who goes through foreclosure. Credit score damage is only temporary. A foreclosure will stay on your credit report for seven years. You can begin rebuilding your credit long before that, especially if you have other active, positive accounts on your credit report after the foreclosure.

Even the prospect of homeownership isn’t ruined by a strategic default. People who’ve gone through foreclosure can often get a mortgage within two to four years after foreclosure with a good down payment and a strong post-foreclosure credit history.

While the cost of strategic default can be overcome with time, homeowners considering strategic default have to think very carefully about the long-term benefits and consequences.

Sources: IRS.gov, MSN.com, DailyFinance.com