Here’s When You Should Give up Your Mortgage
All homeowners quickly realize that buying a home is only the first step. Depending on the length of your mortgage, you’ll have approximately 360 more steps to take in the form of monthly mortgage payments. And that doesn’t include other costly steps like paying for maintenance , property taxes and insurance premiums. Suddenly you may realize that you are poorer than you expected.
Of course, there is home poverty, and then there is home poverty —when you can’t afford to continue living there and paying the mortgage. Half the country reported difficulty paying their mortgage or rent this year alone, and the standard advice remains the same: Contact your lender, look into government programs and consider a short sale. But there is another option that may make sense under the right circumstances: walking away and defaulting on your mortgage.
Strategic default
” Strategic default ” on a mortgage is simple: you stop paying your mortgage and redirect those funds to other areas of your life. This is sometimes called a “voluntary foreclosure” because you essentially give up your emotional attachment to the house , give it back to the bank, and let them try to sell it to recover the money owed on the loan.
Strategically defaulting on mortgages may be a good idea under a limited set of circumstances. But before you decide to just pack your bag and run for it, take a moment to consider the very real and very negative consequences of foregoing your mortgage:
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Credit rating hit. As you can imagine, this step will significantly lower your credit score – up to 160 points .
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Housing issues. Landlords may not rent to you if they check your credit, making it difficult to get another mortgage.
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Judgment of deficiency. In some states, if your foreclosed home doesn’t sell for the full amount owed, the bank can claim the balance from you , turning strategic default into simply a delaying tactic.
Forfeiting your mortgage has real consequences and should not be taken lightly. That being said, it might be worth considering if you find yourself in the following scenario.
You’re underwater
Like, underwater . A home is considered flooded if the amount owed on the mortgage exceeds the current market value, and it is considered “severely” flooded if the gap is 25% or more . So, if you owe $200,000 on a house and its market value is $150,000, congratulations! You’re seriously underwater.
At that point, it could take years to recoup the cost of the house —years during which you’ll still be paying your mortgage, assuming you can afford to keep making payments. And even if you hang on by your fingernails and keep up with the mortgage, you’ll likely never break even on the investment when you factor in all the other costs of owning a home. Loan modification can be challenging when you’re underwater, so chances are you’ll never get your capital back and a short sale won’t cover the amount owed. In this case, it may make sense to walk away instead of throwing good money away for bad, especially if you can’t afford the monthly payments anyway.
Your credit history is already bad
As noted above, a strategic default on your mortgage will have a negative impact on your credit score for years to come. But if your credit score is already considered poor, the hit you’ll take from a strategic default won’t matter much in the short term.
However, one thing to consider is the recovery time. Relatively minor financial mistakes that hurt your credit score will go away in a few months, but restoring your credit score after a foreclosure, voluntary or otherwise, can take about three years . You will need to consider how a bad credit rating will impact your life for the foreseeable future. But if your credit is already ruined, giving up your mortgage will only make the situation worse, leaving you free to use the money you put toward your mortgage to pay off other debt, increase your savings, or otherwise right your financial ship.
No judgment about shortcomings
Finally, make sure you live in a state that does not allow judgments of disadvantage . For example, let’s say the house described above (where you owe $200,000 on your mortgage but the house is appraised at $150,000) is located in the state of Florida, allowing for a deficiency judgment. You walk away and the bank ends up selling the house for $135,000, leaving $65,000 remaining on the loan. The bank issues a deficiency judgment to you and begins to withhold your wages. This means that you have used up your credit only to pay off your mortgage in the slowest and most painful way possible.
If your home is underwater, your credit is in tatters, and you live in a state that doesn’t have foreclosure judgments, a strategic mortgage default can save you a lot of money and may be your best bet. Otherwise, it’s almost always better to work out a modification with the bank or try to sell the house you can no longer afford.