What happens if you walk away from a mortgage?

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We still have millions of people upside down in homes even as the housing recovery is starting. So what do you do if you’re still sitting there staring up from the bottom of a well?

I took a recent call from someone in California who was upside down on her home, which is now worth roughly a third of the mortgage balance. She bought at the absolute peak of the market and the odds of her home recovering to the value it sold for at the time of purchase are such a long shot. So the caller wanted to know about strategic default.

We talked about how walking away can hurt your credit and you could be sued for deficiency. Then the caller said something like, “I can actually afford the payments, I just wonder if I’m throwing money down the drain.”

That caused such a strong reaction from people, including those who were upset with me for not bringing up the ethical issue. I later addressed my oversight during a Clark Stinks segment.

But let’s put that aside and address the implications for homeowners, especially in bubble states, who are still facing a dilemma just like our caller.

To walk away or stay put?

The good news is that many of those millions of homeowners who are underwater are not atrociously underwater. Most of the time they’re just 20-25% upside down. At that point, you want to stay in because we are at a trough. The movement from here, in fits and starts, will be a recovery of prices. Stay and you’ll be OK.

It’s really when you have a property worth half or less of what you owe that the choices become so stark and difficult. Some homeowners have a moral dilemma about walking away and won’t do it.

Then there’s the issue of credit hurt. Typically, your score will drop around 150 points or so if you walk away. Second, in most states you are subject to deficiency, as I mentioned.

Deficiency means that if you walk away, the lender can turn around and sue you for their losses on your foreclosure. In some states, lenders may be able to come after you for 36 years!

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So walking away is not without risk. If you’re considering it, it is my belief the best answer in this circumstance is a short sale or a deed-in-lieu of foreclosure. That is the best compromise I know.

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