What Is the Penalty for Walking Away From a Mortgage?

Walking away from your mortgage usually results in a voluntary foreclosure, with the lender taking possession of the home and eventually selling it. It is not illegal to walk away, but the penalties can be numerous, sometimes causing devastating consequences that can last for years.

Judgments

The bank will eventually foreclose on your home after you stop paying the mortgage. The house will eventually be sold at auction to the highest bidder, according to Consumer Credit Counseling Services, or CCCS, of Roanoke, Va. The bank will apply the proceeds to the mortgage balance.

If the sale amount is not enough to cover the balance, the bank could sue you for the difference and win what is called a deficiency judgment. Thus, you could end up walking away from the mortgage but still be forced to pay a portion of the balance.

Taxes

Walking away could also cause tax problems if the mortgage is for a vacation home or secondary residence. In those instances, the entire amount you default on--the mortgage balance before foreclosure--could be treated as income by the Internal Revenue Service, adding to your tax bill.

However, most consumers facing foreclosure will be protected by the Mortgage Debt Relief Act of 2007. According to the IRS, the act usually allows taxpayers to exclude income from the discharge of debt on a principal residence.

Credit

You credit scores are likely to plummet after the foreclosure, which can remain on your credit reports for up to seven years, according to CCCS. A foreclosure can also make it difficult to purchase another home. The Federal Housing Administration, which insures home loans, will not consider applicants who have gone through foreclosure until at least three years have passed. In 2008, FHA-backed loans totaled $429 billion, according to The Wall Street Journal--nearly a quarter of all loans in existence.

Stress

Walking away could also create an emotional burden. You could develop additional stress as you struggled with finding somewhere else to stay, and as you dealt with the embarrassment of possibly having to leave your neighbors and community behind. There's also the stress of fearing more legal and financial burdens as the bank auctions off the house.

Prevention/Solution

You might be able to walk away from your mortgage without incurring penalties. One alternative to foreclosure is called a deed in lieu of foreclosure. It allows you to walk away voluntarily with the lender agreeing not to initiate foreclosure proceedings, and to cancel any that are already under way. The lender also can agree to to forgive any deficiency balance resulting from the sale of the property. Under that scenario, your credit reports would not reflect a foreclosure and you would not face any tax liabilities, allowing you to get a jump-start on repairing your credit and buying a new house.

The FHA and others recommend a deed in lieu of foreclosure as a viable alternative to simply walking away.