Mortgages: Consequences of Walking Away

More homeowners are walking away from their mortgages, even if they can keep up the payments. Falling into foreclosure — voluntarily or not — has become less taboo for many people as they have watched their house values tumble far below the amount they owe, putting them “underwater.”

Purposely defaulting on a mortgage, often called “strategic default,” may be a very rational personal finance decision, but it’s not without major consequences. And it’s not necessarily the best option for anyone underwater who can afford to make monthly mortgage payments but who does not want to wait up to 10 years for the housing market to turn around.

If you go through a strategic default, your lender may file a lawsuit against you, called a “deficiency judgment,” to recoup losses. The lender can demand payment for the unpaid balance: the difference between what you owe, including the foreclosure cost, and the fair market value of the home.

Lenders don’t always bother to go after people who have been forced into foreclosure. But in some states, such as Florida, they have five years to do so.

Some homeowners decide to file for bankruptcy after they go through foreclosure because that can wipe out a deficiency.

But that may not be necessary, because some states have non-deficiency laws that prevent such lender action. Among the non-recourse states are California and Arizona.

But even in those states, lenders can still go after you for a second mortgage. And if you had refinanced the original mortgage, the lender may also be able to file a deficiency judgment against you.

Even if a homeowner can avoid a deficiency judgment, a strategic default will cause other problems — chief among them a drag on credit scores. The stain on your credit score will eventually go away, although it can last for seven years. But if consumers continue to pay other bills on time, the foreclosure may not have a significant negative impact.

Credit scores affect everything from credit cards to cards’ interest rates to the ability to get new credit to getting a new job.

Experts say all options other than default should be considered, because a home can represent far more than the big financial transaction it took to get it, and to keep it.