One of the most common questions or requests for help that I receive goes something like this: “Kevin, my home is severely underwater? Should I walk away? If so, how will a mortgage default affect my credit score?”
Many people who seek my advice on this matter aren’t in dire financial straits. They neither have taken on too much debt nor have been reckless in their finances. Contrarily, they have been reasonably good stewards, but worry that they are in a terrible deal, one that won’t get better anytime soon.
I never answer this question directly, giving only information to help people make an informed decision. Everyone’s situation and values are different. However, new information published today strengthens the decision to walk away from a mortgage in cases where homes are underwater.
Almost two years ago, I wrote a prophetic article “Fair Isaac Corporation (FICO) increasingly irrelevant” in which I posited that banks would rely less on credit scores and more on other subjective factors to assess creditworthiness. It appears that this prediction is a reality, as consultants have created new categories to help banks focus on potential customers who, based on a credit score alone, would be too risky.
As reported today in The New York Times, these new categories (in order of most to least creditworthy) are “strategic defaulters”, “first-time defaulters”, and “sloppy payers”. They help creditors distinguish between consumers who have the same or similar FICO scores.
What does this mean? It means that those who walk away from a mortgage a.k.a. “strategic defaulters” have newfound hope of ascending from the depths of credit purgatory sooner than seven years. According to The New York Times article, strategic defaulters are those “whose credit scores were damaged because they walked away from a home when its value dropped below what was owed on the mortgage. These borrowers made a bad bet on real estate but may otherwise be prudent risks because they make a good living.”
So, in short, this new information will help people solve their moral conundrum of whether or not to walk away from their mortgage. But, as I often say, this game is always changing. What seems like hope today could be horror tomorrow. Make sure you consider all the possibilities and consequences of such a crucial financial decision.