Risks of walking away from mortgage debt
Some homeowners underwater on their home loan -- meaning they owe more on the mortgage than the home's current value -- are turning to "strategic defaults" in which they simply walk away from mortgage debt.
But financial experts warn the cost of skipping out on mortgage debt can be high.
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The American Bankers Association recently warned homeowners about the consequences of strategic default, including the possibility of the bank obtaining a judgment to pursue the homeowner's assets, such as bank accounts, cars and investments.
A foreclosure -- regardless of whether it is because of a strategic default or other circumstances -- also has a negative impact on a consumer's credit score.
"A foreclosure is one of the stronger predictors of future credit risk," says Craig Watts, public affairs director of FICO.
Foreclosures remain on a credit report for seven years, with the impact gradually lessening over time.
"For someone who has a foreclosure on (his or) her credit report, (his or) her FICO score can generally begin to recover after a couple of years, assuming the consumer stays current with (his or) her payments on all (his or) her other credit accounts," Watts says.
Watts says the impact of a foreclosure on a credit score depends on other factors in the borrower's credit history. The ABA says a foreclosure drops a FICO score by 100 to 400 points.
Difficulty getting new mortgage
In addition, a voluntary foreclosure can impact a homeowner's ability to qualify for a new mortgage for years to come.
Peter Fredman, a Berkeley, Calif., consumer attorney, says Fannie Mae and Freddie Mac will not approve a mortgage within four years after foreclosure, while the ABA says it can take three to seven years to qualify for a new mortgage.
In addition, mortgage giant Fannie Mae recently announced a tough new sanction on people who deliberately default on their mortgages. Such borrowers will be ineligible for a new Fannie-backed mortgage for seven years after the date of foreclosure.
Tax liability is another potential danger of defaulting. Although the Mortgage Forgiveness Debt Relief Act of 2007 (extended through 2012) offers widespread protection from federal taxes following a foreclosure, state taxes still may be due on unpaid debt.
A lender can also pursue the remaining debt from an unpaid loan by obtaining a deficiency judgment against the delinquent borrower, or may work with a collection agency to recoup losses.
And of course, ethical questions surround strategic defaults. A survey by Trulia.com and RealtyTrac found that 59 percent of homeowners would not consider defaulting no matter how much their mortgage was underwater, although another 41 percent of homeowners said they would consider a default.