January 19th, 2021 11:34 AM by Jackie A. Graves
See if it ever makes financial sense to turn your back on a home loan.
When most people buy a home, they expect its price will rise over time. But sometimes, the home falls in value, and in some cases the depreciation is so sharp that the amount owed on the mortgage becomes more than the home is worth.
This can make buyers question whether buying the home was a good decision. They may ask themselves: Does it make sense to stay in this home long term, or just simply walk away?
Answering that question can be difficult, but we’ll cover when it makes sense to walk away from a mortgage, how to do it, and other options to consider.
How to walk away from your mortgage
If you decide to walk away from your home, one of the most common options is to choose a strategic default. This happens when a borrower who has the means to pay intentionally stops making payments to allow the home to go into foreclosure.
During the foreclosure process, the mortgage lender repossesses your home for failure to pay the debt. To recover some of the money owed, the lender then sells the home at an auction. For example, if you owe $150,000 on your home and it’s worth only $100,000, the lender may sell the house for $100,000 or less.
If you live in what’s known as a recourse state — a state that allows mortgage lenders to issue a judgment for the remaining balance — you’d be responsible for paying all or a portion of the $50,000 debt that’s outstanding.
By contrast, in a non-recourse state, where the lender has to accept the $50,000 loss, you wouldn’t be responsible for making any additional payments.
A dozen states are non-recourse, according to Credit Sesame:
Whether the remaining debt is forgiven or not, it is important to note that a foreclosure will affect your credit score negatively, and it will remain on your credit report for seven years.
For example, if you have a credit score of 780, being 90 days late on your mortgage could drop your credit score to 650, according to a report from the credit scoring giant FICO.
This could prevent you from being able to purchase real estate for years, so it’s important to do all your research before walking away from your mortgage.
When walking away makes sense
Walking away from a mortgage makes sense when you’re underwater and believe the housing market in your area won’t rebound.
For example, let’s say you’ve purchased a home worth $250,000, but a market crash reduces its value to $150,000. It could make financial sense to walk away if you don’t want to pay the lender more than the home is worth.
If you lived in a non-recourse state, this could prove to be a wise choice, since you wouldn’t be on the hook for the remaining $100,000. Before you decide to walk away, be sure to consider all of your options.
If my mortgage is underwater, what can I do besides walk away?
If staying put makes sense, consider these alternatives:
Stay in your negative-equity home and continue to make payments
If you think the real estate market in your area will eventually recover, it might make sense to continue making payments.
To reduce your overall borrowing costs, consider making extra payments. This way you’d pay off the mortgage faster and potentially save on interest.
Seek a principal reduction
Another way to avoid foreclosure is to ask your lender to reduce the amount you owe. In the past, some government programs have helped distressed borrowers accomplish this, but many of these programs have expired.
Still, it can’t hurt to ask your lender for a principal reduction so you can stay in your home.
Request a loan modification
Ask your lender to modify your loan. For example, you could request that the lender extend the term of the loan or reduce the interest rate. By doing this, you could lower your monthly mortgage payment.
If you have a loan that’s been sold to government-sponsored mortgage giants Freddie Mac or Fannie Mae, consider applying for their Flex Modification program, which is designed to help make your monthly payments more affordable.
Refinance your mortgage after building equity
Refinancing your home is another option, but you may have to wait until you have positive equity. Most lenders won’t allow you to refinance your mortgage with negative equity.
After you’ve built enough positive equity to refinance, you might be able to save money if the lender gives you a lower interest rate.
Sell your house through a short sale
A short sale occurs when you sell the home for less than the mortgage is worth. For example, let’s say you owe $130,000 on your mortgage, but due to a bad housing market its value has fallen 25% to $97,500.
Some mortgage companies will allow you to sell the house at or below its value.
As with a foreclosure, the same recourse lending laws apply. If you’re living in a recourse state, you’d be responsible for paying all or a portion of the remaining $32,500 balance. Speak with a real estate lawyer if you have questions regarding the laws in your area.
It’s also important to note that, like a foreclosure, this option has a negative impact on your credit score. A short sale without an additional balance reduced a credit score of 780 to the range of 655 to 675, according to FICO.
With an additional balance, the 780 score was reduced as low as 620.
Use a deed in lieu of foreclosure
Instead of allowing the lender to foreclose on your home, you could voluntarily give the title to the lender instead. When this happens, the lender agrees not to foreclose. If the lender agrees, you won’t be responsible for the remaining amount owed on the mortgage.
As with foreclosure and a short sale, it’s important to note that using a deed in lieu of foreclosure also will negatively affect your credit rating.
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