Recently, banks and other industry groups have noticed a phenomenon of homeowners, who can afford to pay their mortgage, deciding that it is no longer financially sound to do so. Instead of opting to continue to pay for their mortgage, which is well above the value of their home, they simply stop paying, wait for eviction and move on. They take a hit to their credit, but they can then go on to purchase another home in two or three years at a significantly lower cost or they can rent a similar place for a much smaller monthly payment.
Pros to Strategically Walking Away from a Mortgage
The biggest pro is the ability to save a significant amount of money. Borrowers have found they may be able to save as much as $1,000 per month renting vs. paying on a mortgage that is significantly overvalued. Some buyers have been bold enough to purchase a second home at a much lower value before defaulting on their first. By doing this, they continue to gain the positive benefits of homeownership (appreciation/tax break), reduce their monthly payments and get out of a very bad financial contract on their first home. Sometimes the second financial institution may be aware what the buyer is doing.
Some borrowers argue that if banks were willing to forgive some of the debt, they would not have to go to such elaborate measures to reduce their debt and achieve a more manageable monthly payment. Others argue that they have the right under the documents they sign to walk away. The bank has established in their mortgage contract that in event of default they have the right to take back the property. These borrowers say they are only living up to the contract by giving the bank their collateral back instead of continuing to pay on an underwater loan.
Cons to Strategically Walking Away from a Mortgage
The two biggest cons are ethics and the negative credit effect. Ethically, many people in the baby boomer generation grew up with the philosophy of paying one's debts. Furthermore, banks lend debt on property, not equity. Since banks do not have any right to participate in the upside if the property appreciates, why should they have to participate in the downside?
On the credit front, borrowers should expect a foreclosure to remain on their credit for at least seven years. Importantly, however, a foreclosure may only prevent some good credit borrowers from obtaining a mortgage for two to three years. With the large number of foreclosures hitting the market today, borrowers can expect lenders to be more forgiving in the future.
Regardless of the view of strategic walkaways, it is becoming a great percentage of foreclosures everyday. While it may be a financially savvy avenue for many distressed borrowers, it does raise ethical questions about the role of lenders. When considering this financial strategy, weigh the pros and cons. Borrowers should make the decision that feels most comfortable to them.
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