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Do You Walk Away?

Walk away from your mortgage?  This is the situation that many homeowners are facing today.  Arizona Law Professor, Brent White, says do it - go ahead and walk away from the mortgage.  It may be the most financially responsible thing to do.  While Professor White’s arguments definitely have merit, I would offer a word of caution before anyone takes this route.  BTW, the technically term for walking away from a mortgage is “strategic default”.

One of Professor White’s biggest argument is that too many homeowners may have a sense of “moral” obligation to stay in an underwater mortgage (mortgage balance is much higher than value of home):

Individuals should not be artificially discouraged on the basis of “morality” from making financially prudent decisions, particularly when the party on the other side is amorally operating according to market norms and could have acted to protect itself by following prudent underwriting practices. The current housing bust should be viewed for what it is: a market failure – not a moral failure on the part of American homeowners. That being the case, it is time to take morals out of the picture and search for an equitable solution to the negative equity problem.

I agree that from a homeowners perspective this decision should be viewed as a business decision - void of emotion and a sense of moral obligation, but there are serious consequences to walking away from a mortgage that should not be overlooked or minimized.  Most importantly, individual homeowners circumstances are quite different.  Here are some of things to consider before deciding to walk away:

1)  Have you exhausted only your options?  This may require talking to a HUD-approved housing counselor or an attorney specializing in real estate and foreclosures.

2)  Have you spoken to the lender directly regarding the possibility of a loan modification?  It doesn’t hurt to ask and some lenders may be willing to work something out BUT even with this be very careful.  What matters is that the monthly loan payment is structured significantly lower and extraneous fees should be limited to non-existent.  Some lenders have been adding various fees and doing weird things with loan terms with the final result being that the monthly loan payment doesn’t change and in some cases higher.

3)  Do you qualify for the government’s weak-ass loan modification program called HOPE?

4)  How long will your credit score and ability to obtain credit in the future be effected in the event of a strategic default?  Even Prof. White in his paper mentions the potential impact to credit score:

Just how much impact a foreclosure has on one’s credit is unclear because the Fair-Isaac Company will not share this information. But generally one can expect a 100 to 150 point hit to his or her credit as a result of a foreclosure, and additional hits for each late payment – which are generally reported separately from the foreclosure itself. See How Foreclosures, Short Sales, and Bankruptcies Affect Your Credit Score, AMERICAN BANKING NEWS, Oct. 8, 2009, http://www.articlesbase.com/real-estate-articles/how-does-foreclosure-impact-your-credit-report-234979.html. The total hit from late payments and a foreclosure could be as much as 300 to 400 points. Additionally, one must wait seven years before the foreclosure disappears from one’s credit report entirely.

But he continues, and I don’t necessarily agree with his assessment:

Just how much impact a foreclosure has on one’s credit is unclear because the Fair-Isaac Company will not share this information. But generally one can expect a 100 to 150 point hit to his or her credit as a result of a foreclosure, and additional hits for each late payment – which are generally reported separately from the foreclosure itself. {See How Foreclosures, Short Sales, and Bankruptcies Affect Your Credit Score, AMERICAN BANKING NEWS, Oct. 8, 2009, http://www.articlesbase.com/real-estate-articles/how-does-foreclosure-impact-your-credit-report-234979.html.} The total hit from late payments and a foreclosure could be as much as 300 to 400 points. Additionally, one must wait seven years before the foreclosure disappears from one’s credit report entirely.

The reason I disagree with this assessment is that just like Professor White said, we don’t know for sure how FICO would score a strategic default.  If more people start exercising strategic defaults Fair-Issac Company, the company that operates FICO scores, can easily help out lenders and punish people more severely in the future.  The impact of a strategic default on credit score is not definite.

5)  Don’t overlook the potential for a Deficiency Judgment.  Most form mortgages (many state foreclosure laws allow Deficiency Judgments) have a provision in them that gives the lender the right (or option) to seek more money from the borrower if the foreclosure sale falls short of paying off the balance of the mortgage.  The legal term is Deficiency Judgment.  Again some states allow for Deficiency Judgments and it depends on language of the form mortgage and whether lender would exercise this option.  This is where consulting with an attorney familiar with state foreclosure law would be very helpful.

I totally agree with Prof. White that homeowners should put aside the “moral” obligations that may be keeping them in an underwater mortgage.  But like all good business decision we have to make sure: 1) that we have all available information to make an informed decision; 2) that we exhausted less costly options and 3) that we weighted the costs and benefits (ignoring the moral aspects) of strategic default.

Good luck.

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