If the effects of the recession have left you with a home or condo that is worth less than the amount of your current mortgage balance, you may have considered a strategic default.
A strategic default is when a borrower decides to default on their mortgage — basically refuses to make payments — and walks away from the loan.
The bank will obviously report this delinquency to the credit bureau. But for many borrowers, the cost savings and the ability to be financially free from a burdensome home is enough to prompt this type of drastic move.
Reasons Why People Consider a Strategic Default
An increasing number of borrowers with very strong credit and a healthy credit history are choosing a strategic default in recent years.
Foreclosure defense attorneys warn that borrowers should consider all of the long-term consequences of this type of move, but many are still going ahead with it.
According to a national survey by Reecon Advisors, nearly one out of 10 homeowners, or 7.4 million, would be likely to choose a strategic default strategy if they were in a situation where their house was worth less than what was owed on the mortgage.
Many homes have fallen “underwater†from the recession, and most homeowners are finding it impossible to sell their homes for anywhere close to pre-recession prices. While there is always the option to wait it out and hope that your home value improves when the economy turns around, this could take several years.
Effects of a Strategic Default on Your Credit Score
Officials from Fair Isaac Corp., creators of the FICO credit score, report that borrowers who choose a strategic default on their mortgage typically lose about 150 points from their credit score. This is a significant amount when you consider that the highest FICO score you can have is 850. Unless you have a very high score — somewhere above 750 points – you could put yourself at risk for a very poor credit rating from this single move, at least in the near-term.
The effects of a drastically lower credit score include:
- Difficulty obtaining a home loan at an attractive interest rate
- Inability to open up new lines of credit
- Missing out on low-interest credit card offers
- Being turned down for even a basic personal loan or auto loan from a bank or other financial institution
Still, thousands of homeowners are choosing a strategic default just so that they don’t have to deal with a mortgage that is now underwater. They feel like they’re “throwing good money after bad†to keep paying a lender for a house that’s clearly not worth what’s owed on it.
If you have considered strategic default to catch up financially, or to simply walk away from a house that doesn’t make economic sense to own, the good news is that the hit to your credit rating doesn’t have to last seven years.
Yes, it’s true that negative information, such as a foreclosure, will remain on your credit reports for seven years. But it’s also the case that how well you handle your finances after a strategic default is equally critical.
For example, since the credit-scoring system places a heavy emphasis on your payment behavior in the two most recent years, you can help restore your credit rating more quickly by making sure that you pay all your bills on time following a strategic default.
Also, to the extent it is possible to isolate the strategic default, doing so will help your credit rating. In other words, if it’s feasible, pay your other obligations on time — such as your car note, credit card bills, etc. That way, the credit-score damage from the strategic default will still be severe, but not as bad as it would be had to let all your bills go delinquent.
The bottom line is that you can bounce back and recover after a strategic default or a foreclosure. And it won’t necessarily take as long as you may have thought.
“Ask The Money Coach†is a syndicated column written by personal finance expert Lynnette Khalfani-Cox, co-founder of the free financial advice blog, AskTheMoneyCoach.com. Follow Lynnette on Twitter at @themoneycoach.