Strategic Default: Walking All Over Your Credit Score?

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If you walk away from a mortgage you choose not to pay, know this – you’re also walking off a cliff, as far as your credit is concerned.

The decision to stop making mortgage payments – a process more formally known as “strategic default” – is usually triggered by a cold, hard reality. The homeowner realizes that he or she is “underwater” on their home loan, or, in other words, that they owe more on the mortgage than the home is worth.

Depending on how far “underwater” they are is and their expectations for the real estate market in that area, they may have little or no hope of ever recouping that lost equity. The credit score will suffer as soon as those late payments – and ultimately, foreclosure – show up on the owner’s credit report card. But many homeowners view this as a temporary hurdle, one worth going through given the “savings” they would realize by substituting a bloated mortgage payment with much cheaper rent.

How big a problem are strategic defaults? According to a study from the University of Chicago Booth School of Business, 35 percent of mortgage defaults in September 2010 were “walk-aways”, up from 26 percent in March 2009.

Even as strategic defaults grow in number, some economists say that skating on your home mortgage is an understandable, and even worthwhile strategy. University of Arizona law professor Brent T. White stands squarely in that camp. He penned a paper entitled“Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis in October, 2010, that says homeowners, if they get over their moral qualms involved, can save “hundreds of thousands of dollars” by walking away from their mortgages.

White says that any short-term impact, say a big drop in the homeowner’s credit score, is easily outweighed by the cash saved from walking away from a losing proposition, mortgage-wise.

“While the actual financial
cost of having a poor credit score for a few years may be hard to quantify, it is not likely to be significant for most individuals, especially not when compared to the savings from walking away from a seriously underwater mortgage,” he says.

But just how serious is that ‘short-term” impact? And should it so easily be dismissed?

FICO recently released information on how mortgage delinquencies affect FICO scores, giving for the first time specific examples of the number of points a foreclosure can shave off a homeowner’s credit score. See them in the table below.

But that’s just for starters. Here’s a list of other financial disasters that can befall a homeowner who just can’t resist the temptation of walking away from their mortgage:

1. The seven-year itch

Foreclosures, the end result of any strategic default, will stay on your credit report for seven years.

2. No new mortgage

You won’t be able to get a home mortgage anytime soon. Major mortgage loan providers like Fannie Mae and Freddie Mac won’t green-light a new loan for seven years after a strategic default – compared to four years for a straight-up foreclosure.

3. Big hit on taxes

Just because you shaken loose from a lousy mortgage doesn’t mean you’ve shaken loose from the taxman. Many states will go after defaulters for any unpaid debt on their homes after a strategic default. Just note that states laws apply here, with some states much harsher against strategic defaults than others. Federal tax may be forgiven thanks to the Mortgage Debt Relief Act of 2007, but that’s not a guarantee. (Read more on the rules in our story about the pros and cons of short sales.)

4. Your lender could come after you

If you ditch your house – and your mortgage payments – your mortgage lender may have some heavy-handed legal recourse. Unless you live in a so-called non-recourse state, mortgage lenders won’t hesitate to deploy their armies of lawyers, who know how to land deficiency judgments against strategic defaulters.

If you can live with the above financial burdens hanging over your head, and you want to at least consider a strategic default, you’ll need to start crunching some serious numbers. Do that with the “Should I Pay Or Should I Go” calculator on PayorGo.com.

If you decide its “go time,” don’t kid yourself. You might be going, but you’re taking a truckload of financial problems along with you.

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Published May 6, 2011 Updated: April 13, 2016
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CAS•  May 6, 2011 Edit
those 4 penalties are far far better the being 200k underwater on a 350k mortgage and watching those who perpetrated this financial meltdown (or as greenspan calls it "a slight flaw") get away with fraud, get bailed out with my tax dollars, and receive bonuses for failure.
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Pat•  June 3, 2011 Edit
The problem with a short sale with big lenders like BAC is they ask you to sign a Promissory Note for any deficiency, which constitutes prima facie evidence of the original note they can use against you later. That severely limits the borrower's defenses to any deficiency judgment in recourse states where MERS Corporation is named Mortgagee. Two federal courts have found that because MERS (or its assignees) didn't hold a beneficial interest in the notes they were foreclosing, they couldn't claim the money in judicial proceedings. It doesn't prevent them from foreclosing in non-judicial states but creates a formidable defense for any borrowers defending himself from a deficiency judgment brought by a MERS assignee. Only the original investor(s) who funded the loan would have legal standing to collect any deficiency brought in behalf of a MERS-securitized mortgagee in a recourse state. If you can convince the servicer to waive the deficiency (good luck!) in writing then a short sale is for you, otherwise just default and let the chips fall where they may. It will cost the bank a lot more to recover that deficiency than it's worth the vast majority of the time, esp. if it's a MERS note. Read more: http://wellingtonshortsaleagent.com/what-is-wellington-short-sale-strategic-default/#ixzz1OE46Ua7Z
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