Why Not Walk Away from My Mortgage?

Kelli writes in:

My husband and I are sitting on a thirty year mortgage (with twenty six years left to go). We still owe $330,000 on our home. A week ago, a very similar home to ours two blocks away sold for $220,000, so we’re under water by at least $100,000. We are thinking of just walking away from this mortgage and renting an apartment for a while until our credit clears up. What do you think?

First of all, there’s a strong personal moral element to this type of decision. Is it morally wrong to walk away from a mortgage? You’ll get strong, impassioned answers on both sides of the question. Some will argue that if you make an agreement with another entity, you’re obligated to stick to it to the best of your ability. Others will argue that banks know what they’re getting into with a mortgage and that foreclosure is a risk they accept in the agreement, so you’re just doing something within the bounds of the agreement.

As with most morality questions, I can’t tell you what to think. I personally feel walking away from your agreements when you have the capacity to fulfill them is morally wrong, akin to lying. If I were a lender, I would never lend to someone who walked away from a mortgage because I would simply view them as too big of a risk. But I’m not a mortgage lender.

Aside from that moral concern, though, is it really a good financial choice? I think it can be, but it depends on the other choices that the person makes.

First of all, walking away from a mortgage will drop your credit rating by 150 points and it will take several years to recover. Such a drop has a huge impact if your credit is good, but a much smaller impact if your credit is already bad.

What kind of impact? It will become incredibly difficult to get a car loan or another mortgage with any sort of competitive interest rate. Lenders will look at your credit score and if your score is low, they won’t offer you a prime loan (if they offer you one at all). You have to accept that you’ll either be paying for cars and homes in cash for the next several years or you’re going to be taking out loans with incredibly painful interest rates and down payments.

If you’re going to do this, your best approach is to make sure you have housing and automobiles lined out for the next several years before your credit collapses. If you’re going to get a mortgage on a second home, do it now and get a fixed rate mortgage while your credit is still good. If you’re going to rent, get your rental agreement set up now before you walk away. If you’re going to need a car in the next seven years, you might want to make the move now (unless you’ll have the cash to do it later).

Another impact is that many other services use your credit ratings to determine what to charge you and whether to do business with you. Insurance is one example of this – most insurance companies regularly do a “soft pull” of your credit and use declining credit as a reason to raise your rates. Many upscale renters will do the same thing and not rent to people with poor credit, which may limit the places where you can rent your housing. Potential employers often pull your credit (I’ve had two employers in the past do this) and use that as an element of their hiring decision, often leaning towards people with good credit over people with poor credit. These are all serious additional costs of walking into foreclosure.

In the end, I don’t think Kelli should walk away from her mortgage as a first response. She should try several other avenues first that would preserve her credit and perhaps even allow her and her family to remain in the home.

First, I’d simply talk to the lender. Explain your situation and discuss options available to you. It’s often easier for a lender to just refinance with you (sometimes even removing some of the principal) than it is to put the homes in foreclosure. Many lenders are currently focused on refinancing in this way rather than taking on more foreclosed homes, so it’s certainly an option.

Second, I’d look at the extra financial costs of what will happen if you do foreclose. Run the numbers carefully here. Include all the extra costs – a serious bump in your insurance rates, for example – and make sure you also include some estimate of the cost of the risks mentioned above – the extra cost of a new car or the challenge of finding a rental home or a new job. Those things have serious financial costs if they occur – or they might have no cost at all. A good way to appraise it is to figure out the cost if it does happen, then estimate the odds of it happening. So, if something has a cost of $100,000 and has a 40% chance of happening, it’d be a $40,000 cost.

You might be surprised to find that staying put is the best option, even if you happen to be underwater in your mortgage. If you still find that abandoning is the best option. then it becomes the moral question discussed above – and moral questions are things we all have to decide for ourselves.

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