What Is Voluntary Foreclosure?
A voluntary foreclosure is a foreclosure proceeding that is initiated by a borrower who is unable to continue making loan payments on a property, in an attempt to avoid further payments and prevent involuntary foreclosure and eviction. Borrowers may choose this option if their mortgage is significantly underwater.
This is different from an involuntary foreclosure, which is initiated by the lending institution in order to take possession of a property to recover the lender's losses and is typically the last option for borrowers unable to make payments on their loans. Borrowers can seek a voluntary foreclosure from a bank or other lending institution for both residential and commercial properties.
There are several similar terms that can be used for voluntary foreclosures, including strategic default, walking away, jingle mail, and friendly foreclosure.
- A voluntary foreclosure is initiated by a borrower who can no longer make loan payments on a property and seeks to avoid foreclosure by the lender.
- Voluntary foreclosure can be harmful to a borrower’s credit ratings, but it is usually not as financially damaging as an involuntary foreclosure.
- The subprime mortgage crisis of the late 2000s, when many mortgages were underwater, led to a significant rise in the number of voluntary foreclosures.
Understanding Voluntary Foreclosure
Voluntary foreclosure is extremely harmful to a borrower’s credit ratings and can make it difficult to rent or buy a home and get loans approved for years afterward, but it is not as financially damaging as an involuntary foreclosure. Therefore, it can be a cost effective option for some borrowers who, rather than struggling to make payments each month, conclude that they are unable to continue making payments. Many debtors plan for a voluntary foreclosure by opening new credit cards and taking out new car loans and mortgages before their credit rating drops. Lenders will often agree to a borrower’s request for voluntary foreclosure because it can make the process of retaking property and collecting debts much faster and more cost effective than an involuntary foreclosure.
Reasons for voluntary foreclosure include a sudden and unexpected job loss (such as during the coronavirus pandemic), the realization that one is living beyond one's means, and changes in the housing market along with variable interest rates (if a borrower has an adjustable rate mortgage, or ARM, for instance).
A deed in lieu of foreclosure is one of the most commonly used types of voluntary foreclosure. The rules, laws, and penalties for voluntary foreclosures vary widely by lending institution and state.
Pros and Cons of Voluntary Foreclosure
If you are considering initiating a voluntary foreclosure, it's important to carefully consider the advantages and disadvantages of taking such a step. You need to balance it against the effect on your credit, the loss of your home, how much financial relief it offers you, and any alternatives you may still have. If you are unable to get a loan modification or do a short sale, for example, a deed in lieu of foreclosure may have less impact on your credit reports than an involuntary foreclosure.
Cutting your losses
One advantage, especially if your home is significantly underwater, is that you can cut your losses when you stop making payments. However, some states allow lenders to go after borrowers for a "deficiency"—the difference between the amount you still owe on the loan and the foreclosure sale price—via a deficiency judgment. Make sure you know the laws of your state on this score.
Lowering your credit
Your credit score will take a major hit if you foreclose. The repercussions: It's likely to be harder to get new credit—say, for a car loan or a new credit card—and the interest rates you'll be offered will be higher.
Finding new housing
You'll need to find another place to live, and landlords may refuse to rent to you or charge a higher monthly amount. And if you are looking to buy, you may not be able to get a mortgage for a few years; Fannie Mae, for instance, applies a four-year wait period before granting a new mortgage after a deed in lieu of foreclosure.
A faster, less complicated release from debt than an involuntary foreclosure and an opportunity to cut your losses
A deed in lieu of foreclosure may have less impact on your credit scores than an involuntary foreclosure
There's less social stigma attached than with an involuntary foreclosure
You still may be subject to a deficiency judgment
Your credit score will take a hit and getting new credit (a car loan, a credit card) may be harder and come with higher interest rates
Although there's less stigma, employers may still deem you ineligible for certain jobs
Example: Voluntary Foreclosures and the Housing Crisis of 2007-2009
Prior to the American housing bubble and subprime mortgage crisis of the late 2000s, voluntary foreclosure was a rarely used option for borrowers struggling to afford their property loan payments; however, it has become much more widely used in the years since. In 2007 and 2008, housing prices plunged, often posting double-digit declines in value.
At the start of 2010, approximately 25% of all mortgages were underwater, meaning the amount owed on the mortgage was more than the value of the home. According to some reports, voluntary foreclosures more than doubled from 2007 to 2008 and represented more than 25% of all defaults in 2009. Voluntary foreclosures have remained common over the past decade, as home values have still not increased enough to free many borrowers from the burden of negative equity.