Risks of walking away from mortgage debt

Less risky in some states

Despite the potential negative consequences of a strategic default, the move is less risky in some states than others.

"The first question for anyone considering a strategic default is whether the homeowners will be liable for the debt anyway," says Fredman. "Each state has different rules."

Non-recourse laws protect homeowners in some states. When a borrower defaults in one of these states, the lender can take the home through a foreclosure but has no right to any other borrower assets. (Home equity loans are not eligible for this protection unless they were used as part of the home purchase.)

According to research from the Federal Reserve Bank of Atlanta, 11 states are "non-recourse" states: Alaska, Arizona, California, Iowa, Minnesota, Montana, North Carolina, North Dakota, Oregon, Washington and Wisconsin.

"In California, we have some of the best anti-deficiency rules around, so banks can foreclose on the home but cannot get any other judgment to claim additional assets," Fredman says.

In some areas, lenders are so overwhelmed with defaulting customers that homeowners can live in their homes for free for months or even a year or more before the foreclosure is complete.

The average length of time from default to eviction is 400 days in California, Fredman says.

Price of freedom

The potential consequences of strategic default cannot deter some homeowners from taking the plunge, says Frank Pallotta, executive vice president and managing director of the Loan Value Group in Rumson, N.J.

"While everyone understands the credit score impact of a strategic default, most borrowers don't seem to care," Pallotta says. "They think a 200-point hit on their credit score cannot offset the benefit of living for as long as 18 months rent- and mortgage-free. They see strategic default as a form of financial freedom, especially if they live in a non-recourse state and know someone who has done this."

Fredman -- who developed the "Should I Pay or Should I Go" Web calculator to help consumers evaluate the wisdom of a strategic default -- says homeowners considering a strategic default should research state regulations about loan defaults and tax laws. Even non-recourse states have various laws that can impact defaulting borrowers, he says.

"I also think everyone should consult an attorney and probably an accountant, too, because the relative cost of these professionals is not nearly as high as the potential cost of making a mistake," he says.


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