Walking away from a mortgage can feel daunting, but sometimes it’s necessary due to financial hardships or changing circumstances. While defaulting on a mortgage can have serious consequences for your credit score and financial future, there are strategies you can employ to mitigate the damage and protect your credit.
In this article, we’ll answer the question, “Can you walk away from your mortgage without ruining your credit?” Then, we’ll provide a few strategies.
What Is “Walking Away From A Mortgage”?
Walking away from a mortgage, or strategic default, involves intentionally stopping mortgage payments. Some people make this decision despite having the financial ability to make them.
What’s going to happen when you do this?
Foreclosure. You’re taking a significant risk when willingly facing foreclosure. You’re not just facing the loss of your home but hefty late fees and damage to your credit score. Ignoring your mortgage obligations is not a viable solution. Most states offer options for struggling homeowners, such as loan modifications or short sales, which require proactive engagement with your lender.
Remember, a mortgage is a binding contract, and defaulting can ruin your credit for up to seven years. If you find yourself in a financial bind, exploring these legal avenues is crucial rather than simply walking away.
Consequences Of Defaulting On A Mortgage
Defaulting on a mortgage occurs when a borrower fails to make the agreed-upon mortgage payments.
The first day you’re late for your mortgage payment is typically the 16th day of the month. Banks and lenders usually extend a 15-day grace period. Expect to receive calls and letters from the bank reminding you to take care of payment.
After 30 days without making a payment, your lender will consider the loan to be in default. Once a mortgage loan defaults, your bank or lender’s aggressiveness and effort to receive payment will increase. They can also begin the foreclosure process when they see fit by sending a right-to-cure notice.
We 100% recommend selling your house during the foreclosure process instead of waiting.
Here’s why:
- Firstly, your credit score will take a significant hit due to late payments and the default
- In some states, lenders can pursue a deficiency judgment if the foreclosure sale does not cover the full mortgage amount. This judgment allows the lender to collect the remaining balance from the borrower.
Underwater On Mortgage
In 2008 and 2009, property values plummeted, with many homes experiencing double-digit declines. By early 2010, 23.1% of mortgages nationwide were underwater, meaning homeowners owed more than their properties were worth.
Typically, you can sell your home to pay off your mortgage, but this isn’t feasible if your home’s value has dropped below the mortgage balance. If you’re underwater, your options include loan modification, refinancing, or a short sale, where the lender allows you to sell the home for less than the owed amount.
The Best Options
If you’re underwater on your mortgage, consider these options instead of walking away.
Selling Your Home
Selling should be your first option if you can’t afford your home. There are a few things you need to keep in mind whether or not you’re already in foreclosure.
- Time Constraints: When your home is foreclosed, you work against the clock. The foreclosure process moves relatively quickly, so you have a limited window to find a buyer and close the sale before the lender takes possession of the property.
- Lender Approval: Unlike a traditional sale, where you have complete control over the sale process, selling a home in foreclosure often requires approval from your lender. The lender has a financial interest in the property and wants to ensure that the sale price is sufficient to cover the outstanding mortgage balance and associated fees. Sometimes, lenders allow short sales (we’ll discuss that shortly).
- Limited Marketing Time: Due to the time constraints of the foreclosure process, you may have less time to market your property. This can make attracting potential buyers and negotiating your home’s best price challenging.
- Condition of the Property: Your home may have suffered if you’ve been struggling financially. This can affect the sale price and its attractiveness to potential buyers.
- Liens: Besides missing mortgage payments, homeowners sometimes have liens from other entities, such as the IRS and creditors, on their property. Most traditional buyers won’t buy a house with unpaid liens.
These things mean you need to find a buyer fast and communicate with your lender. Our advice is to consult an attorney with your last few pennies.
Short Sale
A short sale occurs when you sell your home for less than the remaining mortgage balance. In this process, all sale proceeds go to the lender, who may then forgive the remaining debt or pursue a deficiency judgment, requiring you to pay the shortfall.
To initiate a short sale, you must approach your lender, explain your financial hardship, and request approval. This option is preferable to a foreclosure, as it can be less damaging to your credit score. It allows for a more controlled and dignified exit from your financial obligations.
Deed In Leui Foreclosure
A deed in lieu of foreclosure is when a homeowner transfers the title of their property to the lender to be released from mortgage debt. This option helps avoid the formal foreclosure process. To initiate, you must contact your lender, explain your financial hardship, and request this option.
Lenders may agree to this if it saves them the costs and time associated with foreclosure. However, they can reject your request if they believe foreclosure would be more beneficial or if there are other liens on the property. To increase your chances of approval, provide thorough documentation of your financial difficulties and demonstrate that other options, like a short sale, were unsuccessful.
Refinance Your Mortgage
Refinancing your mortgage can help avoid foreclosure by replacing your current loan with a new one, often with better terms. The process begins by assessing your financial situation and applying for a refinance loan with your lender or a new lender. You’ll need to provide documentation of your income, credit history, and home value. If approved, the new loan pays off your existing mortgage, potentially lowering monthly payments and extending the loan term.
Lenders consider refinancing if you have a stable income and a good credit score. However, they may reject applications due to poor credit, high debt-to-income ratios, or insufficient home equity.
For example, if you owe $250,000 at 5% interest with a monthly payment of $1,342, refinancing to a 3.5% interest rate could reduce your payment to $1,123, easing financial strain and helping you avoid foreclosure.
Rent Out Your Home
If you can’t afford your home, consider renting out all or a portion of it to ride out the wave.
- Pro: You can easily cover your home’s mortgage without having to sell.
- Con: Many tenants are pigs (just being honest). And if you’re not an experienced landlord, you may get stuck with deadbeat, professional tenants.
As a landlord, you need connections and a system for repairs, leasing, and legal. It’s not a walk in the park. You also need to ensure that renting out your home doesn’t violate the terms of your mortgage. Mortgages for rental properties are generally higher than residential. You may also lose your homestead exemption, which will raise your property taxes.
Assuming that you’re not a professional landlord, you’re going to need three people on your roster.
- An attorney
- A CPA
- A property management company
An attorney to help you understand all of the residential tenancy laws. A CPA to help stay financially compliant and above water. Lastly, get a property management company, pay their fee, and let them handle the details.
Sell To A Real Estate Investor
If the clock is ticking, your last (but not worst) option is to sell your home to a real estate investor. Selling to a real estate investor is usually quicker than a traditional sale.
You can close on a home in as little as 72 hours, but the process from offer to closing usually takes 2-3 weeks. Buyers don’t have to get pre-approved, which takes about 7-10 days. The sale can close just as quickly as the title company clears any liens, provides insurance, and prepares paperwork.
Most investors will pay up to 70% of the value of your home if they plan to flip it.
Will A Foreclosure Ruin My Credit?
A foreclosure typically remains on your credit report for seven years. So, why does it affect your credit so much? A foreclosure indicates to lenders that you defaulted on a significant financial obligation.
This drop in credit score can have far-reaching consequences.
You may face difficulty qualifying for future mortgages, renting an apartment, obtaining a car loan, or even passing job background checks. Foreclosure is a major red flag to potential lenders and landlords, making it challenging to secure financing or housing.
Government Options
For individuals struggling to afford their mortgage, several government aid programs and options can provide assistance.
- Home Affordable Refinance Program (HARP): HARP allowed underwater homeowners (those who owe more on their mortgages than their homes are worth) to refinance their loans. Though HARP ended in 2018, replacement programs like the High Loan-to-Value Refinance Option may be available.
- FHA’s Home Affordable Modification Program: This program assists FHA-insured homeowners in default by reducing their monthly mortgage payments to an affordable level.
- Making Home Affordable (MHA) Programs: Various MHA programs offer assistance, such as Principal Reduction Alternative (PRA), Second Lien Modification Program (2MP), and Home Affordable Unemployment Program (UP).
- HUD Counseling Agencies: The Department of Housing and Urban Development (HUD) provides access to free or low-cost housing counseling services to help homeowners understand their options and develop a plan.
- VA Loan Modification Programs: Veterans Affairs (VA) offers loan modification options for veterans who are struggling to make mortgage payments on VA loans.
The Truth: There’s Consequences To Walking Away
Walking away from a mortgage might seem tempting, but the long-term repercussions on your credit and financial future are significant. Instead, explore options like selling your home, short sales, refinancing, or renting out your property.
These alternatives can help you manage your mortgage crisis without enduring the severe consequences of foreclosure. Remember, government aid programs and professional advice are available to support you. You can protect your credit and work towards a more secure financial future by taking strategic steps.
