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One option a homeowner has when they cannot or no longer want to pay their mortgage payment is to simply walk away from it, known in the industry as "walking away from a mortgage." That's not saying it's good practice -- it falls more into the category of "it is what it is," meaning that some people do it. And doing so might be their best option. Here's how to tell.
How to walk away
If you decide walking away from your mortgage is what you want to do, you'd just stop making the monthly payment on your mortgage note.
Note that if you can afford to make the monthly mortgage payment but choose not to because you believe the investment no longer makes sense for you to keep, you'd be practicing "strategic default." The resulting foreclosure is the same whether you can afford to make the payments or not. Either way, if you stop making your mortgage payments, you'll soon be in default, and your lender will foreclose.
Why an investor would walk away from a mortgage
Being underwater on a mortgage usually triggers a real estate investor to consider walking away from that mortgage. It doesn't usually make financial sense to continue paying a mortgage when what's owed is more than the property's worth, a situation that often happens when you pay too much for the property to begin with. That can easily happen with a cash deal, such as when buying a rental property or a flip, since no appraisal is needed.
At the top of a housing bubble, even when buyers take out a mortgage and need an appraisal, homes can appraise for top dollar. But as we saw during the housing crisis, house prices can come crashing down without much warning.
How to determine whether you're underwater
Before you assume you're underwater on your mortgage, make sure you really are. Here are some steps you can take.
- Look at your mortgage statement to find what you owe.
- Next, determine what your home is worth by searching real estate prices online for homes comparable to yours (comps), ideally nearby, which recently sold. You can get a good ballpark figure for your home's worth by doing that.
- Finally, subtract your mortgage balance from the value of your home. If your mortgage is more than the home's value, you're underwater, also called being upside down, on your mortgage.
Options in walking away
A short sale happens when you sell the property to a third-party buyer for less than what you owe. Your mortgage lender would need to agree to this transaction. You would also want to know whether your lender would forgive the deficiency or come after you for it.
The outcome of a deed in lieu of foreclosure or a voluntary foreclosure is the same as a regular foreclosure: The bank takes back the property. The differences are the lender releases you from what you still owe on the mortgage, and a voluntary foreclosure might not look as bad on your credit report. Your lender would need to approve a voluntary foreclosure.
The type of loan you have, typically depending on the state where you live, might be the determining factor regarding whether you walk away from your mortgage or not.
Some loans are nonrecourse loans, meaning the borrower is allowed to walk away from the mortgage, and the bank can't come after your other assets. It's kind of like a "get out of jail free" card. Of course, the opposite would be true with a recourse loan: The bank could come after your other assets to pay the debt. State law usually determines whether a loan is a nonrecourse loan.
Nonrecourse states, or those states that allow only nonrecourse loans for mortgage debt, are the following:
- North Carolina
- North Dakota
With the other 38 states, your loan could be recourse or nonrecourse.
The Millionacres bottom line
If you live in a nonrecourse state, the state is practically inviting you to walk away from your mortgage. This might be the best option for you, especially if you have little equity in the property or haven't put much money into it.
Keep in mind, however, that your credit score will be tanked, and you'll have bad credit for the next seven years. If you don't plan on taking out another mortgage loan or renting an apartment, your credit score might not be too much of an issue.
There is that moral issue, however -- the one that might make it hard for some people to sleep at night. If you're the type who would be bothered by not honoring an obligation, walking away from a mortgage might not be the best solution for you. Plus, real estate investing is often about holding onto your investment property. So you might want to try to do that, as homes in the real estate market often increase in value over time.
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