A recent study by the credit reporting firm Experian found that 25% of pending foreclosures are “Strategic foreclosures.” While the negative equity situation caused by the recent housing crisis may have many homeowners considering this type of move, the risks are high.
Strategic Foreclosures: Risks And Rewards
A strategic foreclosure occurs when a homeowner decides to walk away from a mortgage while continuing to pay off other debt. Borrowers who choose this route are often motivated by high monthly mortgage payments on homes that are valued at considerably less than the value of the loan. An increasing number of homeowners make the back-of-the-napkin calculation that a monthly rent at one quarter of their current mortgage payment makes more sense than continuing to pay on a property that has lost 30% or more of it’s value. A strategic foreclosure comes at a price, however, and you should understand all of the implications before choosing this drastic solution.
Credit impact. Despite making a “strategic” decision to walk away from a bad investment, a strategic foreclosure will impact your credit score to the tune of 150 points or more—those with good credit will feel more pain than those with lower starting scores. The dent in your credit score will stay in place for a minimum of seven years and the listing of foreclosure that comes with this penalty doesn’t indicate the nature of your decision. A drastically lower credit rating will not only make it difficult or impossible to purchase another home, it may also lower credit limits and increase interest rates on existing credit cards.
No recourse. Some states allow banks to pursue borrowers for the full amount of the loan, regardless of the homes value (called resource rules) while others only allow banks to collect on the value of the home outstanding. In either case, you can still face legal action as the bank tries to recover its funds. Such actions can include civil suits and wage garnishments.
Statute of limitations. In most states, there is a seven-year statute of limitations on lender’s recourse. That means, while the current climate may be favorable for strategic foreclosures, there’s always the chance that public (and legal) sentiment might change and banks may come looking to recover what they can.
Another option. If you really feel that getting out of your home makes the most sense, you might want to consider a short sale. In a short sale, your lender agrees to allow your home to be sold for less than the loan amount and you agree to accept the difference as un-taxed income. You’ll still be on the hook for state and federal taxes on the money, but you’ll be free of your home in a much less damaging manner. With foreclosures on the rise (strategic and otherwise), lenders are more receptive to the idea of a short sale than they have been in the past.