Defaulting on Your Mortgage Has Severe Consequences
There was a recent article in the New York Times by Roger Lowenstein talking about the moral versus economic considerations of voluntarily walking away from your mortgage and your house. Lowenstein touches upon some of the possible financial consequences of foreclosing on a home, but focuses most his energy on criticizing the Mortgage Bankers Association for making the issue of mortgage delinquency a moral one, when he believes it should be more of a business decision.
The morality of not honoring a contract can spark a heated debate. But the negative economic consequences for the homeowner and mortgage holder can be substantial, regardless of how a business or investment manager would behave regarding their financial contractual commitments.
According to the First American Loan Performance Index, U.S. home prices doubled on average between 2000 and 2006, and have since fallen about 30%. Zillow.com reports that approximately 20% of homeowners with mortgages are now "under water," meaning the home is worth less than the mortgage balance. But the decision to 'walk away' from the mortgage and give up the home cannot be made based on a pure business calculation.
Paying on debt that is higher than a home's value might not make business sense, but a business doesn't have to worry about the same consequences that people do. If a homeowner decides to 'strategically default'. meaning not pay even if he or she can pay, there are very negative consequences which could be greater than the cost of continuing to pay a higher mortgage on a devalued house.
The following are three very negative personal financial consequences to walking away from your mortgage:
1. Foreclosure or 'deed in lieu', where you allow the lender to take possession of your home, has a severe impact on your credit score. You are not paying back what you owe.
In an article by Elizabeth Weintraub that appears on About.com, she interviewed David Steep, manager at Vitek Mortgage in California, who stated that if a homeowner is having difficulty paying on a mortgage and elects to walk away, the drop in that person's FICO score could be 200-300 points. The average FICO score these days is mid-to-high 600s, so that is a devastating drop.
2. Each state has different laws concerning deficiency balances if a homeowner stops paying their mortgage and gives a home to the lender. When the lender sells the home in an auction or to another party and the amount received is lower than the mortgage owed, the difference is called a deficiency balance.
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