What Happens When You Walk Away From a Mortgage?

Walking away from a mortgage signifies a homeowner’s deliberate decision to stop making scheduled mortgage payments and abandon the property. This action is taken when continuing to pay the mortgage is no longer financially feasible or desirable, often due to a decline in property value or a change in personal financial circumstances. While not illegal, ceasing mortgage payments carries implications for the homeowner, initiating a formal process with the lender.

The Foreclosure Process

When a homeowner ceases mortgage payments, the lender initiates foreclosure to reclaim the property. This process begins after a period of missed payments, generally when a borrower is 90 to 120 days delinquent. After three to four months of missed payments, the lender issues a Notice of Default (NOD). This notice informs the homeowner they are in breach of the mortgage agreement and that foreclosure will commence if the overdue amount is not paid.

The Notice of Default marks the beginning of the pre-foreclosure period, providing a window for the homeowner to address the default. During this time, the homeowner might reinstate the loan by paying the past-due amount, including any penalties and fees. If the default is not cured, the foreclosure process advances, with specific steps depending on whether the state follows a judicial or non-judicial foreclosure process.

Judicial foreclosures involve the court system, requiring the lender to file a lawsuit and obtain a court order to proceed with the sale. This method can be time-consuming and costly for the lender.

In contrast, non-judicial foreclosures occur outside of court, based on a “power of sale” clause in the deed of trust. This process allows a trustee to initiate the sale without direct court supervision. Non-judicial foreclosures are faster and less expensive for lenders. If the default remains unresolved, the lender issues a Notice of Sale, publicly announcing the upcoming auction.

The property is then sold through a public auction to the highest bidder. Upon sale completion, ownership transfers to the new buyer. If the former homeowner does not vacate voluntarily, the new owner can initiate eviction proceedings to gain possession.

Financial Consequences

Walking away from a mortgage triggers financial consequences for the homeowner, impacting credit, debt obligations, and tax liabilities. The immediate impact is on the homeowner’s credit report and score. A foreclosure is reported to major credit bureaus and remains on a credit report for up to seven years from the date of the first missed payment. This derogatory mark causes a drop in credit scores, making it difficult to obtain new credit, secure favorable interest rates, or rent another home for several years.

Homeowners may face a deficiency judgment. A deficiency occurs when the property’s sale price at foreclosure is less than the outstanding mortgage balance. A deficiency judgment is a court order allowing the lender to pursue the homeowner for this remaining debt. The ability of lenders to pursue deficiency judgments varies by state, as some states have “anti-deficiency laws” that limit or prohibit lenders from collecting the shortfall. In states where allowed, lenders can use methods to collect, such as wage garnishment or placing liens on other assets.

Homeowners who walk away from a mortgage may also encounter tax implications related to “canceled debt.” If a lender forgives a portion of the mortgage debt, this forgiven amount can be considered taxable income by the Internal Revenue Service (IRS). The lender issues Form 1099-C, Cancellation of Debt, to the homeowner and the IRS, reporting the amount of debt canceled. While exclusions for certain qualified principal residence indebtedness have existed, they are temporary and apply under specific conditions.

Alternatives to Walking Away

Homeowners have several alternatives that can help address financial hardship and potentially avoid the repercussions of foreclosure. A loan modification involves a permanent change to the original terms of the mortgage agreement. Its purpose is to make monthly payments more affordable for borrowers experiencing financial difficulties. This can be achieved by lowering the interest rate or extending the loan’s repayment period.

A short sale is where the homeowner sells the property for less than the amount owed on the mortgage. This option requires the lender’s agreement, as the sale proceeds will not fully cover the outstanding loan balance. The lender receives the proceeds from the sale and may then either forgive the remaining debt or pursue the homeowner for the difference, depending on state laws and the agreement terms.

A deed in lieu of foreclosure offers a voluntary way for a homeowner to transfer ownership of the property directly to the lender. In exchange for the deed, the lender agrees to release the homeowner from the mortgage obligation, avoiding the formal foreclosure process. This option can be quicker and less costly than a full foreclosure proceeding. Lenders may consider a deed in lieu when the homeowner demonstrates financial hardship and the property has a clear title.