Strategic default: When to call it quits on your home that’s worth less than you owe

If your home is worth less than you owe on it you’re not alone, major media is estimating that 1 in 5 or 20% of homeowners owe more than their home is worth. So what the heck are you supposed to do if you’re one of those people? It could take years before you are back to owing just what the house is worth, in some cases this could be 10 years or more. This article will help those folks stuck in this situation figure out what they should do by helping people evaluate the positives and negatives of walking away. For many people, this financial decision alone could be the most important one they’ve ever made. It could be the difference in retiring 10 years earlier, or being able to pay for their kids college.

I’m going to start this discussion by dismissing the moral or ethical implications of walking away from a debt (I’ll save this for you to decide). Rather than focus on what is morally or ethically right to do in this situation, I’m going to focus on what makes the most financial sense. In doing this, I’m going to first show you the upsides and then the downsides.

Starting with the positives (this list may not be all inclusive):

  • Get to live rent free anywhere from 3 months to up to 15 months. Typically people live in their house after the foreclosure process has begun before being evicted for around 6 months.
  • You can pay off other debts hanging over your head with cash saved in not paying rent.
  • Can go out and rent a much bigger and better place for less money than you are already paying.
  • Instantly take the stress away of staying in a bad situation.
  • Start building for a positive cash flow future.
  • Chance to reevaluate what got you into this situation so you can avoid it next time.
  • With so many people going into foreclosure, banks will likely have to lower their future standards for home ownership, making it easier for you to buy another home with a stained credit report.
  • Banks often pay you to leave the house early. How about an extra few grand just to hand over the keys and leave after your 6 months is up? They would rather do this than fight you in court quite often.
  • Millions of other people are doing the same, people will understand your reasons and not judge you as harshly considering the circumstances.
  • Get out now so you can re buy earlier than others when your credit score is restored. If you’re able to re buy earlier, you’re probably going to get a better deal on real estate than those people who wait and default in a few years.
  • It may be better for you to wait and file bankruptcy and start over, as quick as 2 years after bankruptcy people are eligible to qualify for a new home loan.

And now for the negatives (not all inclusive):

  • Some states allow banks to file deficiency judgments to collect the difference in what you owed versus what your home sells for at auction.
  • It may be more difficult to rent with poor credit. You may be required to put both first and last month rent down or you may not qualify to rent without a cosigner
  • You may face a ton of collection calls
  • You may lose a home that you really love and have a connection to.
  • It will negatively impact your credit for certain.
  • You may owe taxes for the months you don’t pay but still live in the property and even if the property remains unoccupied until someone else takes title.
  • Bad credit could impact future job searches.

Depending on how far upside down you are, it often makes financial sense to simply walk away. If you’re smart about it, you can change your financial position from extremely under to owing very little to anyone in just a few short months. You have to be willing to move away from credit though, and start living life with just cash. You have to ask yourself how long will it take to bring your home value up to what the house is even worth. If you can do that quickly, than staying probably makes sense. If your home is worth 15% less than you owe, and you’re in other debt, you’re probably fighting a losing battle and would be better off walking away and taking the credit hit. You should consider bankruptcy as a way to start over.

In the future, if you’re married and don’t live in a community property state, it may make sense to put the home mortgage in only one spouses name, and put the other spouse on title. This way only one persons credit is ruined if you were to have default. I will talk about this subject in the very near future.

The above article should not be construed as advice, rather as opinion. Consult a professional for specific advice for your situation.

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