Think Twice Before You Walk Away

10/04/2010 10:12 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

You owe far more than your home is worth now. And you have serious doubts that it will ever be worth what you paid for it. So, you’re “under water” on your home.

Why not simply walk away from this terrible investment?

That’s what many people are doing. It’s called a “strategic default,” when a homeowner who could keep paying the mortgage simply decides it’s not worth it.

A recent report found that 31% of US foreclosures in March 2010 were strategic, compared with 22% in March 2009. 

And there are probably more strategic defaults on the way as home prices remain stagnant, or continue to fall in some areas. According to a Deutsche Bank study published in January, 14 million US homes were in negative equity, and the number is expected to rise to 20 million by the end of the year.

Research by Wharton School finance professor Alex Edmans on the subject of “strategic default” notes that while only 12% of US homes in 2009 were in negative equity, they accounted for 47% of all foreclosures.  

Obviously, not all negative-equity foreclosures are considered strategic defaults. It’s one thing to face foreclosure when you simply can’t make the monthly payments, no matter what the value of your home. 

But clearly, the idea of simply walking away from a property that is under water and making a “fresh start,” is catching on. 

Here’s some advice: Think twice before you walk. This decision may catch up to you in ways you never imagined

Of course, walking away from a mortgage and letting your home go into foreclosure will ruin your credit, but that doesn’t seem to be much of a deterrent, even to those who could afford to keep paying. The prevailing sentiment is that “everyone’s credit is in the tank” so it’s not such a scary proposition.

But before walking away, you might want to find out whether your state allows “deficiency judgments.” About half do—and the result is that the lender can go after you in the future, garnishing your wages and invading your bank accounts for amounts lost to the lender when the foreclosed home is ultimately sold. Some states have time limits on enforcing these judgments, but those can easily be extended.

The one big hazard that few people seem to consider is the potential difficulty of buying another home in the future.

Yes, you can rent a fabulous place now for less than you’re paying currently on your under water mortgage. It’s a good temporary housing solution—if the landlord is willing to rent to someone whose home is in the foreclosure process.   

And if you walk away, you’re probably figuring that you’ll be able to buy someone else’s foreclosed property at a much better price than what you paid for your old home.

Don’t count on it! 

These days, even buyers with very good credit have to jump through hoops to get a mortgage.  So, getting back into the housing market may not be so easy with a “walk away” strategic default on your record. 

It’s easy to doubt that home prices will ever reach their 2005 highs again. But don’t bet the roof over your head on that. If inflation comes roaring back, all hard assets will rise in price—including the home you’re thinking of leaving behind.

Are you thinking of a strategic default? Do you think it’s the right thing to do? Please join the conversation and have your say.

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