Homeowners who just walk away

What happens when you walk away

No walk-away service or counseling is a panacea. Mailing back the keys or leaving them on the counter does nothing to change the foreclosure process or its damage to credit.

"There is some kind of irrationality to people's judgment, thinking they can avoid a penalty, said Allan Fishbein, the director of housing and credit policy for the Consumer Federation of America.

Bruises start to show even before the home enters foreclosure; late payments are noted on credit records at 30, 60 and 90 days -- every time a payment is missed. A single missed mortgage payment, says MSN Money columnist and credit expert Liz Pulliam Weston, knocks 100 points off your credit score. Every missed payment thereafter compounds the damage.

A notice of default typically comes after the third missed payment, delivering a knockout blow to the homeowner's credit. Three months after that notice of default, the lender sends out a notice of sale to the highest bidder.

With that sale, the foreclosure is etched on the homeowner's record, usually for seven years. In many states, the (former) homeowner is still liable for the unpaid balance even after the sale.

Some lenders will agree to take a house back and release the borrower from the mortgage, a process known as deed in lieu of foreclosure. It does have the benefit of being more attractive to the lender than a costly foreclosure, especially if the amount owed isn't drastically more than the house is worth.

Still, its effect on credit scores is the same: a haircut of 200 to 300 points.

A short sale, in which a buyer agrees to sell a house for whatever he can get and the lender agrees not to pursue him for the balance, and which shows up as a "settlement" on credit reports, is no kinder to a credit history because it usually comes long after the loan is in trouble.

The direct effect of any of these outcomes on credit scores is dramatic, and it ripples through every corner of borrowers' financial lives. The former homeowners will be unable to get new credit at reasonable rates, and issuers of their existing credit cards can raise interest rates because they are considered greater risks.

"It will prevent you from buying a house or renting a house. It could prevent you from getting a job," said John Mechem of the Mortgage Bankers Association.

In some states, insurers calculate a risk score from the same data used to figure credit scores. The lower the score, the higher your rates. (See "5 people who check your credit.")

If you want to stand and fight

Buyers in over their heads have only a few options for keeping their homes.

"The first thing I go after is to try to do a loan modification. It makes a big difference what bank it is," said Santiago, the Florida housing counselor.

A modification changes the terms of the original loan, extending a discounted interest rate, for example, or rolling late payments back into the loan.

A lender must agree, but the advantages are quickly becoming obvious. "It would still be a better deal for a lender to keep the homeowner in the home at the level they can afford rather than forcing them into foreclosure," said Fishbein, of the Consumer Federation of America.

Another option for drowning homeowners is Chapter 13 bankruptcy, which stops the foreclosure process temporarily and gives the borrower time to work out a repayment plan. (See "Your lender doesn't want your house.")

"That doesn't mean you can never recover," columnist Weston said. The foreclosure or bankruptcy may take seven years to drop from your credit reports, but you can begin to rehabilitate your credit almost immediately.

With responsible credit use and on-time payments, you can boost your scores to near-prime levels in three to four years. Home lenders may shy away from you for a few years after that, although it's difficult to predict future lending conditions or how much of a stigma foreclosure will have once so many people have been through it.

Linda, the housing industry worker from Tampa, agrees. "People need a place to live," she said. "It will pass."

Published April 9, 2008

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