The debate over strategic default— when a homeowner with the ability to afford his mortgage decides to stop paying because his home is worth less than the loan—has largely been one of ethics. Is it morally right to walk away from a legal contract such as a mortgage?
Immoral or not, new data suggests that those who strategically default are a pretty responsible and credit worthy bunch. FICO, the company behind the most widely used credit scoring model, has found that borrowers who walk away from their mortgage obligations tend to pay their bills on time and plan ahead. The majority have a credit score of 620 or better. More than 20% have excellent scores of 740 or higher.
[Related Article: Strategic Default and the Morality of Walking Away]
Strategic default can leave a major stain on your credit score—a loss of 150 points or more, according to FICO. It may take at least a couple of years to rebuild and it will be extremely hard to secure additional financing for several years to come. So, how to prepare for a strategic default to lessen its credit blow? Here’s my advice—and some lessons learned from strategic defaulters in the FICO survey:
1. Open a Credit Card or Two Before Defaulting
That’s what strategic defaulters tend to do. Many, knowing they will walk away from their homes and will have a hard time securing additional credit, apply for credit six months prior to pulling the plug. The idea is not to open up credit accounts to sink further into debt, but just to have access to credit in case of a serious financial emergency.
2. Continue to Pay Your Bills On Time
While strategic defaulters don’t think their mortgages are worth paying, they do manage their other bills and debt obligations relatively well, as evidenced by their higher than average credit scores. Your credit score may take a beating from the foreclosure, but continuing to pay your other debts can help restore your credit faster.
3. Prepare to Rent
Last summer Fannie Mae ruled that strategic defaulters would be barred from Fannie Mae loans for seven years from the date of foreclosure. Unless you have enough cash to purchase a home without a loan, you need to get comfortable being a renter for some time. Keep in mind— walking away from your mortgage may raise some red flags—even with landlords who check credit histories before extending a lease to tenants. Having ample savings to help pay your first 3 to 6 months of rent upfront in cash may help convince a landlord you’re not going to walk away from your lease, either.
[Consumer Resource: Take the Debt Diet Challenge with Jean Chatzky and Credit.com]
Image by Vicious Bits, via Flickr