It’s never an easy decision, but if you've defaulted on your mortgage payments and find yourself significantly underwater with your home, there’s not much point, from an economic perspective, in trying to keep your house unless you can get your monthly payment reduced under a modification program, or by working something else out with your lender (and many lenders do want to keep you in your house).
It probably makes sense to give up your house if it's now worth at least 25% less than you paid for it. That’s because your house’s value would have to appreciate by as much as it dropped for you to come out even, and that will likely take several years. Also, there's no point in putting time and effort into trying to hang on to your house if you really, truly can’t afford it.
What if you bought your house with no down payment (or almost none), or took out an interest-only loan? In that case, you had no equity to begin with—so right now you could give up the house without losing much, financially, right? It’s true that you wouldn’t lose any equity by walking away, but you could end up liable for some or all of your mortgage or home equity loan debt (called a "deficiency"). Or you might be taxed on the amount of the mortgage debt canceled by the lender. (For more on the tax consequences of foreclosure, see our article on how the IRS treats canceled mortgage debt.)
If you decide that the smartest course is to give up the house, you have more decisions to make—important ones. Just how you choose to proceed can make a very big difference to your financial future.
Once you decide to give up the property, your options could include:
Although it’s always painful to give up a house, try to keep in mind that doing so might make things much easier for you and your family in the long run. You will probably be able to stay in the house for months without making any more mortgage payments—giving you time to save some money, which will make moving easier.
If you want to learn the specifics about how foreclosure works in your state (including how long a foreclosure will likely take) and your rights under state and federal law, talk to a foreclosure lawyer. If you want to learn the pros and cons to filing for bankruptcy, talk to a bankruptcy lawyer. If you want information about different foreclosure alternatives and how to apply for one, a HUD-approved housing counselor is a good resource.