Your Mortgage: When It's OK to Walk Away

Recently a distressed reader wrote to me wondering whether he should stay in his Detroit home or just give up and walk away. His main gripe—like some eight million other Americans—is that his mortgage is far more than the home is currently worth. He isn’t building any equity and probably won’t at any point in the foreseeable future. So, should he just stop paying and let the bank deal with it?

My reader Michael (not his real name) has an extremely high interest rate of 8.6%, making his monthly payment roughly $1,850. Plus Detroit has the highest unemployment and foreclosure rates in the country, so a quick market recovery there is not likely. 

“The area is starting to decline due to many vacant or vandalized homes with several break-ins, three for myself,” Michael writes. His credit is already poor, he says, and he no longer uses credit cards. He is married with two young kids.

More Reasons to Walk Away
More middle-of-the-road homeowners are grappling with the same issue as Michael. It's not necessarily because they can’t afford their monthly payments, but because they are “underwater,” owing more on their mortgage than the home is currently worth. They’re not building any equity and when time comes to sell, they’ll probably be in the hole.

The IRS has made it less of a tax pain to give up on your mortgage by now offering special tax relief for financially strapped borrowers who lose their home due to foreclosure.  Previously, so-called “forgiven” debt was considered taxable income.

As the fixed-income team at Credit Suisse noted at the end of last year, “Should the downward spiral in home prices, neighborhood condition and equity deterioration continue, more and more mainstream borrowers are likely to walk away from their homes.”  Credit Suisse also predicted that more than eight million mortgages would enter into foreclosure over the next four years. That’s about 16% of all mortgages.

In Michael’s case, he definitely needs to move to a safer neighborhood. Three break-ins in one month is more than enough reason to flee.  But should he abandon his mortgage? Should anyone ever abandon their mortgage? That’s an entirely different question, so I asked a few experts to weigh in: Joe Brusuelas, a director at Moody’s Economy.com (Stock Quote: MCO); Gerri Detweiler, a credit advisor for Credit.com and Jon Maddux, CEO and co-founder of YouWalkAway.com, a site that helps distressed homeowners learn about their alternatives, such as ditching their mortgage.

When It’s OK to Walk Away
Even for Joe Brusuelas from Moody’s Economy.com, who is not a fan of walking away from a mortgage, ditching your mortgage sometimes make sense.  But it’s an exception, not a rule, he says. “There may be a narrow range of conditions under which walking away from a home that is so far underwater is rational,” says Brusuelas.