When we think about foreclosure, we usually think of it as something that happens to people involuntarily. Most people want to keep their homes and won't walk away from them unless they can no longer afford the payments for so long that the lender forces them out. (Foreclosure is the biggest fear of any struggling homeowner. These tips just might save your credit rating. Check out Avoid Foreclosure: Properly Handling An Underwater Mortgage.)
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However, faced with massive drops in the market values of their homes and the prospect that those values may take decades to return to the prices at which they were purchased, some people have opted to go into foreclosure voluntarily in an act known as strategic default. This article will explain how a strategic default works, what its implications are and whether there are any good alternatives.
How Strategic Default Works
Sometimes homeowners with mortgages will walk away from their properties even though they can still afford to make the mortgage payments. If their home has severely declined in value, homeowners will face difficulties if they choose to refinance or sell it because they owe more on the house than it's worth. And if they were to wait for the market to recover and bring the price of their home back up, they might be waiting forever just to break even, let alone for their home's value to appreciate. (Read Your Mortgage: When It's Time To Walk Away to learn more about how long it might take a home's price to recover.)
The only way to get out of this situation, then, is to walk away.
Why would anyone want to get rid of their home? For many people, a house is a very emotional investment. It has memories attached to it - being carried over the threshold, a baby's first steps and birthday parties. But some people are able to take a more businesslike approach to home ownership and see a home that's seriously dropped in market value as a major financial liability - one that might prevent the achievement of financial freedom, not to mention any other goals that cost money to accomplish.
So, some homeowners simply stop making payments, move out and send the keys to the bank. Others stop making payments and wait for the bank to evict them, living rent-free in the meantime.
A foreclosure, whether voluntary or involuntary, will remain on your credit report for seven years and severely damage your credit score. Thus, a foreclosure will make it difficult for you to secure any kind of credit, from credit cards to auto loans. It can aso prevent you from getting the best rates on insurance products in some states. It will make it difficult for you to sign a rental agreement on a new place to live, because most landlords check credit scores and won't be happy to see that you couldn't (or chose not to) handle your last housing payment. It will certainly make it difficult to get approved for a new mortgage anytime soon. Even some employers check credit scores, so a damaged score might affect your ability to get certain jobs.
A foreclosure might lower your credit score by 85 to 160 points. Because of the way FICO scoring works, the higher your credit score, the more points a foreclosure will take off. So at best, you might walk away with a score in the low 600s. Once your score dips below 620, you're considered a subprime borrower.
Choosing strategic default also has social implications. Friends, family members, neighbors and other people who know about your decision may judge you negatively. They may see your behavior as irresponsible and/or immoral. People who are struggling to do everything in their power to keep their homes may resent you.
Perhaps the most important thing to consider is the dreaded deficiency judgment. After all is said and done, the lender might be able to sue you to hold you financially responsible for the difference between the amount you owed on the home and the amount the lender was able to recover by taking back the home. If you don't want to risk owing many thousands of dollars, having your bank accounts frozen and your wages garnished, you should consult an attorney who can advise how your state's laws and customs will affect you.
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There aren't a lot of alternatives to strategic default. You aren't likely to qualify for a loan modification when you can afford your monthly payments, but you can try. You can stay in the home and keep paying the mortgage, obviously, and hope that the housing market recovers faster than you anticipate. A deed in lieu of foreclosure is another option. This means getting your lender to agree not to foreclose if you voluntarily hand over the deed to your home.
You can also approach your lender about the possibility of conducting a short sale, but short sales are difficult to get approved and still damage your credit. It may be worth the trouble, though, as having a short sale on your record rather than a foreclosure could shorten the length of time before you can get another mortgage from four or five years to as little as two years. (To learn more about short sales, read Short Sell Your Home To Avoid Foreclosure.)
Should You Do It?
Attorney Stephen Elias, in his book "The Foreclosure Survival Guide," writes, "It probably makes sense to give up your house if it is now worth at least 25% less than you paid for it." Of course, you'll want to weigh both the emotional and financial aspects of your situation to make the decision that's best for you.
While walking away from your mortgage may seem simple on the surface, it's advisable to get professional legal advice before you proceed. Yes, attorneys are expensive, but they can help you avoid much more expensive mistakes.
Also, since your actions will damage your credit score, you should approach the situation in a manner that minimizes any potential negative consequences. If you will need a new place to live, a new job, any new credit cards or a car loan, secure these while your credit score is still decent.
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