What Is a Strategic Foreclosure?

What Is a Strategic Foreclosure? article image.

Defaulting on your mortgage, like bankruptcy, is something you should try to avoid at almost any cost. Its consequences are numerous—not the least of which being the loss of your property. There are some instances, however, where a homeowner may choose to walk away from a home mortgage loan and deal with the fallout. Strategic default, as it's called, is different from a traditional foreclosure, which typically happens when a borrower becomes unable to make good on their loan.

A strategic default occurs when a homeowner is able to make their mortgage payments but chooses not to. It's something that usually happens after a person becomes "upside down" on their home loan—meaning that the amount they owe is greater than the value of the home. This is also called being underwater or having negative equity.

Walking away from your house can come with severe consequences, especially where your credit is concerned. Before moving forward, give your decision careful consideration as it could have long-lasting effects on your financial life.

What Does It Mean to Walk Away From Your Home Loan?

Reasons beyond a homeowner's control can wreak havoc on a property's value and cause you to wind up with negative equity and limited options. When you're upside down on a mortgage, you may have a hard time selling your home or you might be frozen out of certain other options such as refinancing.

When breaking even on your mortgage is becoming increasingly out of reach, a strategic foreclosure essentially allows you to cut your losses. It may involve redirecting your mortgage payments toward other debts while building up your cash savings until the bank eventually seizes the property. In addition to devastating your credit, which we'll unpack shortly, other consequences may also include:

  • Possible debt after the foreclosure: Once the foreclosure goes through, the bank will likely try to sell the property. In some cases, you may be obligated to pay the difference between your outstanding loan balance and the final sale price (also known as a deficiency balance).
  • Difficulty qualifying for a future mortgage: When applying for another mortgage down the line, lenders will be wary of approving your application if they see that you've defaulted on a past home loan, especially if it happened recently. Others may charge you a higher interest rate or tack on extra fees to mitigate their lending risk.

How Does Walking Away From Your Mortgage Affect Your Credit?

Abandoning your mortgage can have serious and long-lasting effects on your credit. It will likely pop up on your credit report within a month or so of the lender initiating its foreclosure proceedings. What's more, it will remain there for seven years from your first missed payment, and there's no way to shorten this timeline.

Your credit score is also more likely to take a bigger hit if there are other negative remarks on your credit report—like a history of late payments, other delinquent accounts or high credit utilization on your credit cards. Staying current on all your accounts and keeping your revolving balances low can help rehab your credit score after a foreclosure, though it will take time.

Alternatives to Walking Away From Your House

When weighing the pros and cons, you may feel understandably hesitant about going through with a strategic foreclosure. Thankfully, there are some alternatives that could help you get back on the right track financially without having to walk away from your home. Here are some potential solutions to consider:

  • Try to negotiate a short sale. Your lender may agree to let you sell your home for an amount that's lower than what you owe on the loan. Known as a short sale, it allows you to cut your losses in a way that avoids foreclosure. Short sales do have a negative impact on your credit, but it's not as significant as a foreclosure. Think of it as a best-worst option. A similar solution is something called a deed in lieu of foreclosure, which is when the lender agrees to cut you loose from your mortgage payments if you give up the property deed.
  • Consider refinancing. If you're tied to a high-interest loan, a good portion of your monthly payment may be getting diverted from your principal balance. Refinancing and getting a better interest rate can help you chip away at that amount faster—and increase your home equity quicker. As a result, refinancing could help you get out from under an upside down mortgage without having to go through a foreclosure. Be prepared for your lender to say no, however, as borrowers are typically required to have at least some equity in the home to qualify for a refinance.
  • Seek help from a nonprofit organization. Sometimes a little financial guidance can go a long way. Before moving forward with a strategic default, consider reaching out to a nonprofit credit counselor. These organizations are designed to help consumers create a budget, better understand their credit reports and credit scores, and improve their financial literacy. Taking these steps might be enough to help you solve your mortgage woes without defaulting on your loan.
  • Look into a debt management plan. This involves making payments to a nonprofit credit counseling agency that will in turn make sure your creditors get paid. Debt management could help you lower your interest rates and pay down your accounts to free up money you can then put toward the principal balance of your mortgage, which will help you build up more equity.

The Bottom Line

Walking away from your home is never an ideal situation. By all accounts, strategic default is a last resort that could have very serious implications for your credit. Being informed before making a final decision can help keep your financial health intact. The first step is understanding your credit report and scores, which you can view for free with Experian.