Walking Away from Bad Debt

Ever since the mortgage meltdown of 2008-09, millions of Americans have had their homes foreclosed on and there are millions more out there waiting for the axe to fall. However, that isn’t actually the crux of the matter. Because of so many foreclosures, a downturn in the economy and record numbers of unemployed people, homes are becoming harder to sell which in turn is bringing prices down rapidly. Homes are now worth less than they were when purchased in many cases.

Negative Equity

Many people are now losing homes that are worse tens of thousands less then what they owe on them. It is bad enough being foreclosed on, but worse yet when your credit score will reflect what you owe, not what the home is worth! This has caused a great deal of controversy among economists around the country who are scrambling to offer what advice they can to homeowners buried under a mountain of debt. The real issue involves what to do when faced with foreclosure on a home with negative equity.

Ethics vs. Logic

Some economists are urging homeowners being faced with foreclosure to simply walk away if there is significant negative equity in their home. While not exactly a moral/ethical thing to do, they say it is better to walk away from bad debt than to struggle making payments while letting other things fall behind in the process. In a recent article in the NY Times, Professor White of the University of Arizona is quoted as saying that pouring disposable income into what is a toxic asset will set them back further than if they just walk away from that debt. He says at this point it is best to just stop paying their mortgage.

Impact on Your Credit Score

Although there may be times when this is the ‘practical’ thing to do, you still need to consider what this means to your credit score. According to the same article in the NY Times, the impact a foreclosure or short sale will have on your credit score is actually dependent upon what your score is to begin with. If you have great credit from 750 to 780, for example, you will take a hard hit on your credit score by about 150 points. On the other hand, if your credit score is under 700 you may only lose 100 points. It is quicker to recover 100 points which can be done within a year or two but it will take significantly longer to recover 150 points.

Making Your Own Decision

So what should you do when faced with a moral and financial dilemma like this? Some people find that they are unwilling to walk away from bad debt simply because it is morally wrong. Others feel that they owe a greater obligation to their families and walking away is the greater good. If you are faced with negative equity in your home and are unable to get out from under a mountain of debt, talk to a financial advisor. If paying a mortgage on a home that is worth less than what you owe on it is keeping you from making other payments timely, then you are suffering a hit all the way around.

Before you do anything foolish, seek the advice of a qualified financial advisor. There may be other options open to you that you hadn’t thought of. While it may be morally wrong to walk away from toxic debt, it may be your financial salvation. Keep in mind the impact foreclosure will have on your credit score and how long it will take to repair it if a foreclosure is entered on your history. There is much to consider and the decision will not be easy, but in the end, the ball is in your court. The decision is yours.

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