Three Consequences of Strategic Default

You may have read articles or seen posters or other advertisements that encouraged strategic default. So what exactly is strategic default, and is it something that you should consider?

Strategic default is choosing to let your house go into foreclosure even though you have the ability to pay the mortgage. When people say they are walking away from their home, it usually means that they are doing strategic default. It is typically only used by those that owe more on their mortgage than what the house is currently worth, also called being “underwater”. Being underwater can be frustrating, but before making a decision about strategic default, it is important to understand the possible consequences:

  • Credit: The non-payments and foreclosure will show up on your credit report and lower your credit score. How much it is lowered depends on your score before the default and other credit activity. A lower score means it may be more difficult to be approved for credit in the future, and if you are approved, you may have to pay a higher interest rate.
  • Housing: After foreclosure, buying a new home can be difficult. With a foreclosure on a report, you will have to wait three years before you can qualify for a FHA mortgage (one year on rare occasions) and two to eight years before you can qualify for a conforming mortgage (the most common type of non-government loan) depending on the lender. What about getting a mortgage on a new home before the foreclosure? This is not a practical option for most people. You will most likely have to make a sizeable down payment and show that you have the income to pay both mortgages. Chances are that you will have to rent, unless you have family members or friends that you can live with, but finding a rental may take some time, as landlords often check credit.
  • Deficiency balance: This is the difference between what the lender sells your home for after foreclosure and what you owe on the mortgage. In some states, called recourse states, the lender can sue you for the deficiency balance, which may allow them to garnish your wages or take other collection actions against you. In non-recourse states, the lender generally cannot sue you for the deficiency balance, although there may be some exceptions. For example, non-recourse protection may not apply to a refinanced loan or second mortgage.

Other factors to consider include how much longer you would like to stay in the home and how far underwater you are. If you are $25,000 underwater and your home suits your long-term needs, it probably makes sense to just stay put and wait for the market to recover. But if you are $100,000 underwater and your job or family situation requires you to move quickly, you may find strategic default more appealing. At the same time, it may not be your only option. For example, you may be able to rent out your home or get your lender to approve a short sale, where you sell your home for less than what you owe on your mortgage.

Thinking about your goals and the implications of strategic default can help you decide if it is the right choice for you.

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