With sharp declines in home values leaving millions of homeowners "underwater" on their mortgages, there is a growing clamor that many such borrowers would be better off to simply walk away and let their property go into foreclosure.

You can walk away from your mortgage. But you might not get very far.

Here's the problem: giving up your property through foreclosure may not fully absolve you from your debt obligations on the home. A lender may still come after you for any amount not recovered in the foreclosure sale, particularly if you retain other assets or continue to earn a good income. Even families that are completely wiped out may be unpleasantly surprised to find their lenders coming after them years later, once they're back on their feet.

Post-foreclosure collections increasing

Traditionally, post-foreclosure collections have been rare. Many states have anti-deficiency laws, meaning a lender cannot pursue further collection efforts against a borrower once it has taken the home in foreclosure. In others, lenders usually wouldn't bother with post-foreclosure collection efforts simply because the ex-homeowners didn't have any money - that's why they went into foreclosure in the first place.

But several things have changed, making it more likely that lenders will pursue post-foreclosure collections. For one thing, the steep decline in home values means that the debt remaining after foreclosure sales is considerably greater than in the past - providing a greater incentive for lenders to collect. Also, with many "underwater" homeowners choosing simply to walk away from their mortgages in order to save money, foreclosed homeowners are more likely to have assets for lenders to come after - also increasing their incentive.

Second liens may remain after foreclosure

The biggest factor, though, is the increase in second mortgages and home equity lines of credit that now make up a considerable portion of the typical mortgage debt. Even in states with anti-deficiency laws, the ban against pursuing a homeowner for unpaid mortgage debts after foreclosure usually applies only to the primary mortgage used to buy the property!

That means that second mortgages used for down payments, home equity loans and home equity lines of credit are not covered. You're also not covered if you refinanced the original mortgage - the rules only apply to the original purchase mortgage.

In addition, declining property values often mean that lenders who issued second mortgages, home equity loans and home equity lines of credits recover nothing in the foreclosure sale - the entire proceeds go toward the primary mortgage debt. That means they recovered nothing in foreclosure, so their full claim against the borrower is still intact.'

Debt may be sold to collection agencies

Lenders holding second liens in default may opt to sell the debt to collection agencies, which may pursue the debt for years. There are signs that the growing number of mortgage defaults are spurring the formation of an industry specializing in acquiring and collecting such debts.

In some states, there is limit on how long a borrower has to file and pursue a default claim for an unpaid mortgage - in some cases, as little as 30 to 90 days after the foreclosure. In others, a claim can still be filed decades later, provided the lender has renewed the claim.

You may have noticed that you don't have to walk away from your mortgage to be exposed to collection efforts years or even decades after foreclosure. Even homeowners who do their best to keep their homes may find themselves subject to collection efforts years later, once they are back on their feet, for second liens not addressed in foreclosure. This can also apply to homeowners who give up their homes through short sales or deeds -in-lieu-of-foreclosure if they aren't careful.

Make sure debt is extinquished

The key thing is that if you do have to give up your home, either through foreclosure, a short sale or a deed-in-lieu, is to make sure that any further debt obligations are extinguished in the process. This may require some negotiation on your part, which is one reason why it may be best to pursue a short sale or deed-in-lieu instead of simply allowing the property to go to foreclosure - it gives you more leverage with the lenders.

Walking away from a mortgage where your home has lost so much value that it no longer makes financial sense to keep making payments is not necessarily immoral - businesses and investors frequently do the same thing to cut their losses. But there may be financial consequences you did not anticipate, in addition to the damage suffered by your credit rating.

In the end, the only way to fully extinguish all your mortgage debts if you have multiple liens may be through bankruptcy. In any event, you definitely want to consult with an attorney and possibly a financial advisor before going through with a walk-away foreclosure, short sale, deed-in-lieu or other means of giving up the home short of foreclosure.

Published on March 17, 2010