The recent recession has been marked by reduced consumer spending and ballooning debt burdens, rising unemployment and falling home values, and considerable hardships for countless people. The pain is real for those who have lost their jobs (almost 8 million since the recession began) and their homes (1.2 million) (Source: MSNBC, 2010).
Most people who have lost their homes to foreclosure did so because they lost a job, suffered an unexpected illness, or had an adjustable-rate or interest-only mortgage note with monthly payments that skyrocketed. The dramatic decline in property values that we've seen since the peak of the real estate bubble (29% nationwide and much more in some areas) has made it difficult or impossible for people facing financial hardship to sell and move into a less expensive home or relocate for a job (Source: Standard & Poor's, 2010).
Yet, some people whose homes have lost considerable value have simply walked away…even though they can afford the mortgage payment. This trend - strategic defaulting - has been growing in popularity as homeowners decide to cut their losses and stop paying on a mortgage that is far larger than the current value of the home. Mortgages that meet this criterion are considered to be underwater, and recent statistics show 25% of mortgages meet that definition (Source: CNN, 2010). How popular are strategic defaults? Surprisingly popular - they accounted for 31% of foreclosures during the first quarter of 2010 (Source: Housing Watch, 2010).
As with any issue of this magnitude, there are strong opinions on both sides. On one side are those who believe it is highly unethical for a borrower to walk away from a mortgage contract when he's still financially able to make payments. When borrowers enter into an agreement with a financial institution, a legal contract is signed and the borrowers become obligated to make the payments required under the contract. This line of argument holds that walking away from a home and dishonoring the mortgage contract is a breach of good faith between the lender and the borrower and is, therefore, unethical.
On the other side of the issue are those who argue that a mortgage contract is nothing more than a business deal. Like many agreements in the financial world, if the terms no longer benefit both parties, the deal can be broken - ethically and legally (in fact, contracts provide for default and repossession as a possible outcome). Thus, the fact that a home mortgage is just a business deal excludes any moral, emotional, or ethical underpinnings.
Either way, the decision to default - strategically or otherwise - is certainly not one to be taken lightly. First, the borrower's credit rating (based on a scale of 300 to 850) is likely to take a big hit, as much as 160 points (Source: CNN, 2010). Second, it could be difficult to obtain credit for a number of years; and if a future lender does agree to issue another loan, the interest rates may well be higher. Finally, in some states, lenders have a right to pursue a deficiency judgment in court - to pursue the borrowers for any difference between the price at which the foreclosed home sells and the value of the mortgage note.
This past summer, Fannie Mae announced future restrictions applicable to borrowers who strategically default, indicating that strategic defaulters will be disqualified for new Fannie Mae-backed loans for seven years after their foreclosures. Also, Fannie Mae says it will go to court where it can to try to recoup outstanding mortgage debt from borrowers who strategically default.
You need to consider your own financial situation when deciding if a strategic default makes sense for you. If you can afford your mortgage and aren't planning to move for at least 10 years, then it may not matter that your home is worth less than your mortgage today.
On the other hand, if you don't plan on staying in your home for very long, if you purchased your house solely as an investment vehicle, if it is significantly underwater, if you can stomach the effects your default will have on your neighborhood, and if you can save money renting, then walking may be the best financial option for you. Ethical? That's up to your best judgment.