what happens if you walk away from your mortgage (strategic default), you voluntarily stop payments on an underwater home, leading to foreclosure. This action severely damages your credit score for years, potentially resulting in deficiency judgments in recourse states where lenders can sue for the remaining debt, and may incur tax liability on any forgiven debt. Less damaging alternatives include loan modification, short sales, or deed in lieu of foreclosure.
In this article, we’ll break down what it means to walk away from an underwater mortgage, the legal and financial risks involved, and the alternatives that could help you avoid foreclosure while protecting your credit and future financial health.
Understanding the Underwater Mortgage Dilemma
An underwater mortgage occurs when your home’s current market value is less than your outstanding mortgage balance.
Example Scenario:
- You bought your home for $300,000
- You still owe $270,000 on the mortgage
- The home’s current market value is $220,000
- You’re $50,000 underwater
This situation often results from:
- A drop in housing market values
- Purchasing during a housing bubble
- High-interest loans or adjustable-rate mortgages
- Economic downturns and job market instability
When faced with this gap, many homeowners wonder whether it’s worth continuing to pay or if they should just walk away.
What Does “Walking Away” Really Mean?
Walking away, or strategic default, involves voluntarily ceasing mortgage payments, even if you can technically still afford them. In doing so, you effectively abandon the property, letting the bank initiate foreclosure proceedings.
People usually consider this option when they feel the house is a bad investment and they’ll never recoup the loss.
Is It Legal to Walk Away?
Yes, walking away from a mortgage is not illegal. A mortgage is a secured loan: if you stop paying, the lender has the right to take back the property through foreclosure.
However, while you can legally walk away, the consequences — both financial and personal — can be severe and long-lasting.
Recourse vs. Non-Recourse States
The financial consequences of walking away depend greatly on whether your state has recourse or non-recourse laws.
Non-Recourse States:
- In these states, the lender cannot pursue you personally for any remaining balance after a foreclosure.
- The lender recovers the property, sells it, and absorbs the loss.
- This limits your financial liability.
- Examples include California, Arizona, and North Carolina (in specific cases).
Recourse States:
- In recourse states, the lender can sue you for the deficiency — the difference between what you owe and what the property sells for.
- If the lender wins a deficiency judgment, they can garnish wages, place liens on assets, or pursue collection.
Understanding your state’s laws is critical before deciding to walk away.
The Risks of Walking Away From Your Mortgage
While walking away might free you from monthly payments, it comes with significant consequences.
1. Credit Score Damage
- A foreclosure typically lowers your credit score by 100 to 160 points or more.
- This can make it harder to:
- Get approved for credit cards or loans
- Rent a home
- Secure favorable interest rates
- Foreclosure remains on your credit report for 7 years.
2. Deficiency Judgments
- In recourse states, you may be liable for the unpaid balance after foreclosure.
- If the bank sells your home for $180,000 but you owed $270,000, you might owe $90,000 — plus legal and collection costs.
3. Tax Implications
- If your lender forgives part of your debt, it could be considered taxable income.
- For example, if $50,000 is forgiven, the IRS may treat that as income — meaning a higher tax bill.
4. Legal and Emotional Stress
- Foreclosure can bring lawsuits, debt collectors, and court dates.
- Emotionally, leaving a family home under stressful conditions can take a toll on your mental well-being.
Alternative Solutions to Consider Before Walking Away
Before making a drastic decision, it’s worth exploring these less damaging alternatives:
1. Loan Modification
- You work with your lender to adjust the terms of your mortgage.
- This might include:
- Lowering your interest rate
- Extending the loan term
- Reducing monthly payments
- It allows you to stay in your home and can make the mortgage more manageable.
2. Short Sale
- You sell your home for less than you owe, with your lender’s approval.
- It still impacts your credit, but less severely than foreclosure.
- Often used when the homeowner can’t afford the payments but wants to avoid foreclosure.
3. Deed in Lieu of Foreclosure
- You voluntarily transfer ownership of the home to the lender.
- This simplifies the process for both parties and may help avoid a formal foreclosure.
- Like a short sale, it requires the lender’s agreement.
4. Rent Out the Property
- If the market value is low but rent is high in your area, consider renting out the home.
- This can cover the mortgage until the market rebounds.
5. Wait It Out
- If you can afford to continue payments, the market may eventually rebound, and your home could regain value.
- This approach takes patience but avoids credit damage.
A Comparative Example: Walk Away or Modify?
Factor |
Walk Away (Foreclosure) |
Loan Modification |
| Monthly payment | $0 (eventually) | Reduced to $1,400 from $1,900 |
| Credit score impact | -140 points | -40 to -80 points |
| Homeownership status | Lost | Retained |
| Deficiency judgment risk | Possible | None |
| Tax liability | Possible | Avoided or reduced |
| Future home buying wait time | 5–7 years | 2–3 years |
Key Questions to Ask Before Walking Away
Before making any decision, ask yourself:
- Can I still afford the payments?
- Is the home likely to recover its value in the future?
- Am I in a recourse or non-recourse state?
- Have I spoken with my lender about alternatives?
- What are my short- and long-term financial goals?
- Can I emotionally handle leaving my home?
Steps to Take If You’re Considering Walking Away
- Review Your Mortgage Documents
- Understand what your rights and responsibilities are.
- Check State Laws
- Find out whether your state allows deficiency judgments.
- Consult a Real Estate Attorney
- Legal advice is crucial, especially in recourse states.
- Speak With a HUD-Approved Housing Counselor
- They can help you evaluate your options at no cost.
- Communicate With Your Lender
- Being proactive can lead to more favorable solutions.
- Plan for the Future
- Whether staying or leaving, start rebuilding your credit and finances immediately.
Final Thoughts
Walking away may be the right move in some rare cases, especially if:
- You live in a non-recourse state
- Your home is severely underwater with no chance of recovery
- You have no viable income to cover modified payments
However, it’s not a decision to be made lightly. The credit damage, legal risks, and emotional cost can follow you for years.
Key Takeaways
- Yes, you can legally walk away from an underwater mortgage, but the consequences are significant.
- Recourse vs. non-recourse laws determine your financial liability after foreclosure.
- Walking away should be a last resort, considered only after exploring all alternatives.
- Always speak to professionals — legal advisors, counselors, or real estate experts — before making your decision.