When the housing bubble burst and house values fell, many were left paying mortgages which exceeded the value of their homes. Inevitably mortgage defaults and foreclosure rates rose. The financial consequence to those who default on their mortgages and subsequently see their homes foreclosed on is a drop in their credit score. A default will cause a fall in the region of 100 -150 points, with foreclosure resulting in a further fall and a recording of the actual foreclosure on the credit report, which will stand for 7 years.
A high drop in ones credit score makes future borrowing difficult, and a foreclosure will prevent someone being issued another mortgage for several years. Subsequent borrowing is likely to cost more in higher interest rates. There are wider financial implications of mortgage default though, as a high level of foreclosures leads to property prices being further depressed, resulting in more people being caught in negative equity.
Those who do see their homes foreclosed on have the possibility of the mortgage lender pursing them for the remainder of the mortgage debt. Lenders can apply to the courts for a deficiency judgment, but 11 American states do not allow this, meaning that there is no further pursuit of the debt by the lender. Even in the states which do allow it few lenders bother, leaving mortgage defaulters with hardly any financial consequences beyond the hit to their credit score and the loss of any money they have invested in their home.
As more borrowers have been hit with negative equity there has been a sharp rise in strategic mortgage default. This means that home owners simply walk away from their homes and their mortgages, often making a huge financial saving by renting a similar property for half the cost of the mortgage they walked away from.
Many who simply walk away are strategically defaulting, as are capable of affording the mortgage payments, but can see little incentive in continuing to service a mortgage which is double the value of their home. Others simply cannot afford the mortgage payments and default and walk away.
A law professor at the University of Arizona, Brent White, published a paper encouraging mortgage borrowers with negative equity to practice strategic default as a rational solution to the situation they find themselves in. The morality of such a decision is questionable though and would lead to future mortgages costing more as lenders would need to raise costs to insure against this strategy.
Americans who default on their mortgages face far less financial consequences than borrowers in the UK, where it is standard practice for mortgage lenders to legally pursue any outstanding debt after repossession for 12 years.
Source: NY Times