The Consequences of Walking Away From Your Mortgage

If you’ve reached a financial crisis and you’re running out of money and options, you may be contemplating walking away from your mortgage as a means of relief.

Part of your decision should be based on whether you have a recourse or non-recourse loan.

With a non-recourse loan, nothing happens with the lender. “Non-recourse” means that the bank can have the house or what’s left of your mortgage loan, but not both. You can turn over the key and walk away, free and clear. 

If your mortgage contract allows it, the bank can’t come after you for any outstanding balances. If you build in a non-recourse clause, you’ll pay a higher interest rate, but at least it’s available when you need it most.

With a recourse loan, borrowers owe the entire mortgage amount even if they deed the house back to the bank. The lender can sell the house for less than the outstanding mortgage amount and engage you to collect the difference, plus legal costs and fees.

Home equity loans and refinancing are almost always recourse loans, even in states that require non-recourse mortgages when buying a home.

But before deciding to walk away, consider the real, long-term costs of what some experts call a strategic default.

Reasons Why You Might Walk Away

The top reason borrowers strategically default on their mortgages is because they’re underwater. That means your home is worth less than what you still owe. If the housing market crashes, you could find yourself in this situation.

Another reason is that ethically, choosing to walk away from your home can create a moral dilemma. But many people think of walking away as a business decision.

Whether you decide to walk away from your mortgage or refinance your mortgage, the ultimate goal is to change your financial situation significantly. Some borrowers have walked away from underwater homes and rented similar properties in the same area for half the mortgage cost.

The decision to walk away is much easier when you can keep your surroundings, lifestyles, and neighborhoods intact and find a house that meets all your needs for far less money each month.

In non-recourse states, where lenders can’t go after your assets for money owed to them, walking away from your mortgage can free you from a mountain of debt. This creates flexibility to recast your budget so that you can pay off other debts, save for retirement, and get your overall fiscal situation in better shape.

In addition to the financial stress of owning a home, it can also be a physical burden. As a renter, there are fewer responsibilities and costs than the constant maintenance outlays associated with owning your home. At some point, many people are attracted to the simplicity that not being a homeowner provides them.

Some people choose a short sale, which allows you to surrender your home to the bank without leaving the ugly, long-lasting mark of a foreclosure on your credit history.

However, a short sale can be long and frustrating, especially since you cede control to the bank for how much your home sells for. Simply walking away allows you to skip this potentially frustrating process entirely.

Reasons Why You Shouldn’t Walk Away

The first and biggest reason you shouldn’t walk away is that you’ll destroy your credit. When you walk away, you could see a FICO score drop by 200 points or more.

Since credit scores are used for so many things these days, this could hurt your chances at getting a new job, renting a new place, and paying higher rates for credit purchases for several years. Also, credit card companies often cancel cards or lower credit limits as a result of missed mortgage payments.

If you default on your mortgage, it will take years to get another one. Foreclosed borrowers can expect to wait between two and five years before they can get a new mortgage. Borrowers who voluntarily walk away may have to wait even longer. 

Another reason to consider is that if you walk away, the IRS may make you pay taxes on your forgiven debt, which they treat as income. The IRS treats canceled debt like added income. In the agency’s view, if you borrow X dollars from the bank and never pay it back, you are ahead of where you started financially.

There’s a good chance you’ll get a huge tax bill to deal with on top of your other financial challenges.

Also, your other assets may be at risk in recourse states where lenders can go after borrowers for money owed them.

When you walk away from your mortgage obligation, lenders look to collect the difference between what you owe and what they recover by selling your former home. It could be a year or more before lenders get through acquiring and selling your property to determine their loss. 

If they aren’t made whole, there’s a possibility they’ll come after your other assets, including savings accounts, automobiles, second homes, wages, etc. The lender can sue the borrower in civil court and attempt to obtain a writ of execution to reach the borrower’s other assets to satisfy the remaining debt.

The Bottom Line on Walking Away

Walking away from your home is a thorny issue. Before you walk away, consider opening a dialogue with your lender or servicer to see if any cost-lowering or even principal-reduction options are available. 

You should also consider talking to a real estate lawyer and other professionals about the legal and financial ramifications of walking away. Contemplating a more graceful exit may put you in a better position to conduct fiscal damage control and prepare for the future.