Here’s When You Should Walk Away From Your Mortgage

All homeowners learn pretty quickly that buying the house is only the first step. Depending on the length of your mortgage, there are approximately 360 more steps to take, in the form of monthly mortgage payments. And that doesn’t include the other expensive steps—like paying for maintenance, property taxes, and insurance premiums. Suddenly you may realize you’re more house poor than you expected to be.

Of course, there’s house poor and then there’s house poverty—when you can’t afford to keep living there and paying the mortgage. Half the country has 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’s one more option that might make sense under the right circumstances: Walk away and default on your mortgage.

Strategic default

A “strategic default” on your mortgage is simple: You stop making mortgage payments and redirect those funds to other areas of your life. It’s sometimes called “voluntary foreclosure” because you’re essentially putting aside your emotional attachment to the home, giving it back to the bank, and letting them try to sell it to recover the money owed on the loan.

A strategic mortgage default can be a good idea under a narrow set of circumstances. But before you decide to just pack a bag and make a run for it, take a moment to consider the very real, very negative downsides of walking away from a mortgage:

• Credit score hit. As you might imagine, your credit score is going to get hit hard by this move—to the tune of up to 160 points.

• Housing issues. Landlords may not rent to you if they run a credit check, and getting another mortgage will be tricky.

• Deficiency judgment. In some states if your foreclosed home doesn’t sell for the full debt, the bank can come after you for the balance, making a strategic default simply a delaying tactic.

Walking away from your mortgage has real consequences and shouldn’t be done lightly. That being said, it might be worth considering if you fall into the following scenario.

You’re underwater

Like, way underwater. A house is considered underwater when the amount owed on the mortgage is more than the current market value, and it’s considered “seriously” underwater if that gap is 25% or more. So if you owe $200,000 on a house and its market value is $150,000, congrats! You’re seriously underwater.

At that point it could take years to recover the value of the home—years during which you’d still be paying a mortgage, assuming you can afford to keep making the payments. And even if you hang on by your fingernails and keep up with the mortgage, you’ll probably never break even on the investment when you factor in all the other costs of home ownership. Loan modifications can be challenging when you’re that underwater, so chances are you’ll never get your equity back and a short sale won’t cover the amount owed. In that case, walking away instead of throwing good money after bad might make sense—especially if you can’t afford the monthly payments anyway.

Your credit is already bad

As noted above, a strategic default on your mortgage will do a number on your credit score for years to come. But if your credit score is already considered poor, the hit you take from a strategic default won’t make much difference in the short term.

One thing to consider, however, is recovery time. The relatively minor financial missteps that socked your credit score will fade away in a few months, but it can take about three years for your credit score to recover from a foreclosure, voluntary or otherwise. You’ll need to consider how a ruinous credit score will impact your life for the foreseeable future. But if your credit is already trashed, walking away from your mortgage will only make things slightly worse, and you can use the money you were putting into the mortgage to pay down other debt, build up your savings, or otherwise right your financial ship.

There are no deficiency judgments

Finally, make sure you live in a state that doesn’t allow deficiency judgments. For example, let’s say the house described above (where you owe $200,000 on the mortgage but the house is valued at $150,000) is in the state of Florida, which does allow for deficiency judgments. You walk away, and the bank eventually sells the house for $135,000, which leaves $65,000 unpaid on the loan. The bank obtains a deficiency judgment against you, and begins garnishing your wages. That means you tanked your credit just to pay your mortgage off in the slowest and most painful way possible.

If your house is underwater, your credit in shambles, and you live in a state without deficiency judgments, a strategic default on your mortgage can save you a lot of money and might be your best bet. Otherwise, it’s almost always going to be better to work out a modification with the bank or attempt a short sale on a home you can no longer afford.