Say that your house is way underwater. Say that you can pay your mortgage but are sick of throwing good money after bad. Say that you've decided to walk away. Say that your credit score has always been good. What happens?
That depends on the state you live in and what kind of loan you have -- a recourse loan or a non-recourse loan.
With a non-recourse loan, nothing happens -- at least, not with the lender. "Non-recourse" means that the bank can have either the house or what's left of your mortgage loan, but not both. You can turn over the key and walk away, free and clear. Your mortgage contract allows it. The bank can't come after you to collect the rest of the money owed.
You pay a higher interest rate for a mortgage with a walk-away option and should feel free to use it, if that makes sense for your family and your future. It was part of the deal. The bank agreed.
Many states require lenders to give non-recourse mortgages when you first buy the house. You'll find lists of non-recourse states here and here.
If you default, your credit score will take a hit. But as long as you pay all your bills on time, both before and after the default, your walk-away will become less important after a couple of years.
Real estate expert Jack Reed says that, arguably, this is the best possible time to default because so many people are doing it. To future lenders, you're not a deadbeat, you're a person with a good credit record hit by a national catastrophe.
In the oil recession of the 1980s, Reed deeded two Texas apartment buildings back to the bank. After that, he wanted to refinance his California house. The best lender in town wouldn't consider him, he says. But the second-best lender took him on, charging an extra 0.25 percent. Two years later, he refinanced with the best lender. At that point, no one cared what had gone before.
One little hitch: the federal government cares. Don't walk away if your child is in college or approaching it and you're counting on a large, low-cost federal PLUS loan (at 7.9 percent) to pay the costs. Your child will still be able to borrow through the federal Stafford Loan program, but a mortgage default blocks you from getting a PLUS loan for the next five years. You'll be thrown on the tender mercies of private lenders, who will stick it to you.
If you have a recourse mortgage loan, however, the scene shifts. Recourse borrowers owe the full amount of the mortgage even if they deed the house back to the bank. The lender can sell the house for less than the mortgage amount and come after you for all the rest, plus fees and legal costs.
Refinanced and home-equity loans are almost always recourse loans. That's true even in states that require non-recourse mortgages when you make the purchase.
You might also have a recourse loan if you borrowed to invest in a rental property -- say, a single-family house or condominium. The loan may be underwater and you're probably not collecting enough rent to cover your monthly costs.
That's close to a hopeless situation. The investment is draining your bank account, the property won't rise in value anytime soon, and there's small chance of selling for enough money to bail yourself out. To stop the bleeding, you have to sell at a loss and pay the bank whatever it's owed, or else walk away.
Lenders might not pursue someone who's broke. But if they think you have the money, a collection case is entirely possible. Talk to a real estate lawyer before making a walk-away decision, and show him or her your mortgage contracts. Monsters might lie under every clause.
More on MoneyWatch:
Yes, It's OK To Pay Off Your Credit Cards and Let Your Mortage Go
Foreclosure Coming? How About Bulldozing Your House?
Strategic Defaults Increase as Homeowners Choose Not to Pay Their Mortgage
