If your home has become a bad investment, you might be considering defaulting on your payments—even if you can still afford to make them—and letting a foreclosure happen. This tactic to rid yourself of a bad real estate investment is called a "strategic default." Strategic defaults were common during the foreclosure crisis that happened from around 2008 to about 2014, though they're less frequent now.
In this article, you'll learn more about strategic default, the consequences of such a default, and alternatives to simply walking away from a distressed property.
Sometimes a property is so far underwater that it could take years before the home regains all of its value. If that happens, borrowers sometimes choose to stop making payments, even if they could afford to stay current, simply because the home has become a bad investment. This decision is known as a "strategic default," which is also sometimes called "voluntary foreclosure" or "walking away."
Generally, the term "strategic default" implies a different situation than a homeowner who's struggling financially and can't afford to keep paying the mortgage payments. With a strategic default, the borrower does the math and makes a business decision to voluntarily stop making payments, even if it's within their ability to stay current on the loan. After the homeowner voluntarily stops paying, the bank forecloses.
If you're contemplating a strategic default, you should know the consequences and consider them as part of your decision-making process.
In a foreclosure, the borrower's total debt might exceed the foreclosure sale price. The difference between the sale price and the total debt is called a "deficiency."
Example. Say the total debt owed is $300,000, but the home sells for $250,000 at the foreclosure sale. The deficiency is $50,000.
In some states, the bank can seek a personal judgment called a "deficiency judgment" against the borrower to recover the deficiency. Generally, once the bank gets a deficiency judgment, it may collect this amount—in our example, $50,000—from the borrower using normal collection methods, like garnishing wages or levying a bank account.
With a strategic default, you might be liable for a deficiency judgment after the foreclosure, depending on your state's laws. Some states, like California, for example, have anti-deficiency laws. If a state has anti-deficiency laws, a foreclosing bank can't seek a deficiency judgment under specific circumstances. Most homeowners in California won't face a deficiency judgment after a foreclosure. Other states, like Florida, for example, do allow deficiency judgments. To find out if the bank can get a deficiency judgment in your state, see our Key Aspects of State Foreclosure Law: 50-State Chart.
If you walk away from your home, you might have trouble getting a new mortgage loan. Fannie Mae, for instance, has stated that strategic defaulters won't be eligible for a Fannie Mae-backed mortgage for seven years from the date of the foreclosure. Fannie Mae also stated that it will take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments.
Also, a foreclosure could impact your ability to get other forms of credit, like a car loan, and affect the interest rate you receive as well.
If you plan on renting a house or apartment after a strategic default, bear in mind that it's standard for landlords to review your credit report when deciding whether to rent to you. The rental market is competitive, and a landlord might be able to select a renter with better credit over you.
While foreclosure has lost much of its social stigma, many employers routinely run credit checks on potential employees. Because a foreclosure will appear on your credit report, it could cause issues for your job prospects. Of course, whether having a foreclosure on your credit report will affect your options depends on the employer and, to some extent, the reason for the foreclosure. For example, if you're applying to work at a telecommunications company, a foreclosure might not hurt your employment chances—especially if you can show extenuating circumstances, like you had serious medical issues that led to the default.
But if you're applying for a job in the financial services or banking industry, a bad credit report could very well affect your ability to get the job. The potential employer might think that if you couldn't manage your own money, you won't be able to handle someone else's competently.
Arguably, some moral implications are associated with walking away from an underwater home. Strategic defaulters tend to justify walking away from a severely underwater property as something permitted by the mortgage contract itself, which specifies the consequence of a breach. Specifically, the bank can foreclose and take the home. But when you signed the promissory note, you promised to pay the loan back. Some people consider it immoral to voluntarily break this promise. Others don't.
Some options to consider instead of strategically defaulting are:
To find out if you're eligible for an alternative to foreclosure, contact your servicer. If you need information about how foreclosure works in your state, consider talking to a foreclosure attorney.