As home values slip below what people owe on their mortgages, people are strategically defaulting on their loans. Why? Because in some cases, it makes good business sense to walk away from a bad investment -- just like the banks do all the time.
Of course banks like to beat their chests about how walking away from a mortgage will ruin your credit. Truth is, having good credit may be a luxury that no longer makes financial sense for your family -- right up there with taking vacations to Europe and leasing a new car every year.
We spoke to various mortgage and credit advisers, all of whom advised that walking away cavalierly from a financial loan obligation may be injurious to your financial health. But if you are going to do it, they quickly add, do so prepared:1) Seven Year Itch. Know that you won't be able to get another mortgage for as long as seven years. At least that's what Fannie Mae says now. Some people believe that that standard will be relaxed much sooner. It almost has to, various mortgage and real estate agents opined, because the country needs people to be able to buy houses again. If people have a good job and have always paid all their other bills on time, the smart money says that sooner rather than later they will be eligible for another mortgage.
How to prepare: Assuming you are strategically defaulting on a second home, look around your first home and be prepared to stay put for awhile. Are there any large purchases or remodels you want to do before your credit heads south? If you are walking away from your principal residence, start looking at places for rent. How much will you need for a security deposit, first and last months' rent?
2) Car Loan? Forget It. Same is probably true if you were hoping to finance a new big-screen TV. Car dealers and other sellers of big-ticket items will require that you pay cash. Frankly, paying cash for a car makes more financial sense even if you could qualify for a loan, which you can't. So save all the money you aren't spending on a mortgage you never should have gotten in the first place and instead use it to pay cash for a car. In some states, it takes a year or longer for the foreclosure process to be complete and you are living or renting it out anyway without mortgage payments for that whole time. Sock it away.
3) Credit Cards Are Tricky. Your existing ones shouldn't be at risk, assuming you are current on all payments. If you've fallen behind making minimum payments, you may be cut off but that has less to do with your mortgage default and more to do with the fact you didn't pay the credit card bills. If you are 100% current on this and all your other bills, they'll likely leave you alone. If you credit card is tied with the same mortgage lender, it might be smart to open a credit card at another bank and make a few months of on-time payments before you stop the mortgage. With some credit cards, an unrelated default on a mortgage may trigger consequences -- an increase in the interest rate or cap on the credit limit. Call to check.
4) Cash and Carry. How will you pay for things every day? OK, you're one of those people who never carry much cash, but charge everything. You can reacquaint yourself with paper and coin money or you can get yourself a debit card where you draw upon cash directly from your checking or savings accounts. Yes they will charge you fees, and no, you won't collect airline miles or points. But you will be able to use a secured debit card when you go to rent a car on vacation or are asked for a security card at the hotel front desk.
Shane Fischer, a criminal defense and personal injury lawyer in Winter Park, Fla. walked away from a mortgage in 2007 after he lost his job and saw the value of his property collapse to about 25% of what it was once worth. He pays cash whenever possible and brings enough to the table to still get a decent rate on a loan. He was able to get a $25,000 unsecured credit line from a bank because he knew someone at the bank and he underscored that except for the foreclosure, he had perfect credit.
5) Stay Calm. Don't take strategically defaulting lightly, but don't turn into an emotional wreck over it either. This isn't a moral question; it's an economic one. Ignore the condemnation some might heap on strategic defaulting. In a 2008 speech by then-Secretary of the Treasury Henry Paulson, he declared that a man who chose to walk away from an underwater property wasn't "honoring his obligations." Funny, coming from the former chairman of a Wall Street firm who earned billions every year by speculating.
Fundamentally, the question of whether to walk away from your mortgage is a cost-benefit analysis. "It's time to stop paying when the costs of staying significantly outweigh the likely costs of defaulting," said Orlando lawyer Charles P. Castellon. "In most cases, the cost associated with credit harm does not come close to the financial harm of continuing to pay on a deeply upside down mortgage."
Deficiency actions, where the lender comes after you for the balance of the unpaid debt, remain rare in most states. Check if yours is a so-called non-recourse state like California, where lenders can't sue you to recoup their losses. All they can do is repossess the property and report you as a deadbeat. They may also file a 1099 for the difference of what they sold the property for and what you owed them.
Castellon says he doesn't advise a strategic default for those just a few thousand dollars upside down, but certainly would consider it if the property is worth $100,000 less than what's owed and it will take many years to even return to equity.
Interestingly, pretty much everyone has an opinion on whether it's OK to ditch a mortgage -- especially if it's not theirs.
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