hould You Walk Away From an Underwater Mortgage? Risks and Alternatives Explained
Walking away from an underwater mortgage—where you owe more than your home is worth—can severely damage your credit, lead to legal action or tax liabilities, and delay future homeownership. This guide explains the risks of walking away from your mortgage and explores smarter alternatives like loan modifications, short sales, and renting, helping homeowners make informed, strategic decisions in tough financial situations.
What Does It Mean to Be Underwater on a Mortgage?
An underwater mortgage (also known as negative equity) happens when the current market value of your home is less than the remaining balance on your mortgage loan.
Example:
- Outstanding Loan Balance: $360,000
- Current Market Value of Home: $310,000
- Negative Equity: -$50,000
In this case, selling the home would still leave you owing $50,000—making you feel trapped financially.
Common Causes:
- Market downturns or housing crashes
- Buying at the peak of the market
- Low or no down payment loans
- High-interest or adjustable-rate mortgages
- Neighborhood decline or oversupply
Why Some Homeowners Consider Walking Away
When your home’s value plummets and recovery seems distant, strategic default (intentionally ceasing mortgage payments) may appear attractive. Some people choose to walk away if they feel:
- Their financial burden outweighs the home’s benefits
- They’ll never regain equity in a reasonable timeframe
- They’re moving or divorcing and can’t sell at a break-even point
- The property was an investment that no longer cash flows
But what seems like a quick escape can trigger long-lasting consequences.
What Are the Risks of Walking Away From a Mortgage?
Walking away from a mortgage is not just about mailing your keys back to the lender—it carries serious legal, financial, and personal consequences.
1. Credit Score Damage
- Foreclosure can lower your credit score by 100–160 points.
- The foreclosure remains on your report for up to 7 years.
- Your creditworthiness for future loans, rentals, and even jobs may be affected.
2. Deficiency Judgments
- If your state allows it, lenders can sue you for the unpaid loan balance after foreclosure.
- Example: If your loan balance is $300,000 and the bank sells your home for $250,000, you may be sued for the $50,000 difference.
Note: Some states are non-recourse (like California and Arizona), which limits the lender’s ability to sue. Always consult a real estate attorney for your specific state laws.
3. Tax Implications
- The IRS may consider forgiven debt as taxable income, although there are exclusions under certain hardship provisions.
4. Waiting Period to Rebuy
- After a foreclosure, expect to wait:
- 3 years for an FHA loan (with extenuating circumstances)
- 7 years for a conventional mortgage
Smarter Alternatives to Walking Away
Before abandoning your home, consider these strategic and potentially less damaging alternatives.
1. Loan Modification
Renegotiate with your lender to adjust the interest rate, loan term, or principal balance.
- May reduce monthly payments
- Helps avoid foreclosure
- May or may not impact credit
2. Short Sale
Sell the home for less than you owe—with the lender’s consent.
- Lender forgives the deficiency or pursues a partial repayment
- Credit impact is less severe than foreclosure
- Can qualify for a new home loan in 2–4 years
3. Deed in Lieu of Foreclosure
Transfer your property voluntarily to the lender to avoid formal foreclosure.
- May come with relocation assistance
- Still impacts credit, but typically less than foreclosure
- Lender may waive deficiency or seek a settlement
4. Renting Out the Property
If you can’t sell or pay, you might rent it out to cover the mortgage.
- Provides cash flow
- Helps you wait out a down market
- Potential tax deductions on mortgage interest and maintenance
5. Refinance (if eligible)
If your loan is backed by Fannie Mae or Freddie Mac and you’ve been making payments on time, you might qualify for high LTV refinancing options—even if you have little or no equity.
- Could lower your interest rate and monthly payment
- May help you stay in your home long enough to regain equity
Let’s Talk Numbers: Comparing the Options
Here’s a side-by-side comparison to help you evaluate your choices:
| Strategy | Credit Score Impact | Time to Buy Again | Legal/Tax Risk | Notes |
| Walk Away (Foreclosure) | High (-100 to -160 pts) | 3–7 years | High (lawsuit + tax risk) | Worst-case scenario |
| Short Sale | Moderate (-50 to -120 pts) | 2–4 years | Possible tax on forgiven debt | Less damaging |
| Deed in Lieu | Moderate | 3–4 years | May owe deficiency | Faster resolution |
| Loan Modification | Low to Moderate | No wait (if current) | Minimal | Ideal for hardship cases |
| Rent Out Property | Minimal | N/A | None | Best if home is near break-even point |
Tips to Protect Your Financial Future
Navigating an underwater mortgage can be complex. Follow these practical steps to protect your financial wellbeing:
- Check your home’s market value using Zillow or a local CMA
- Get legal and tax advice before making a move
- Communicate with your lender early—don’t wait for missed payments
- Consult with a HUD-approved housing counselor (HUD Locator)
- Explore government and lender hardship programs
Related Articles You Might Find Helpful:
- How to Use Home Equity Responsibly When You Have Bad Credit
- Best Lenders for Home Equity Loans With Bad Credit in 2025
- What to Do if Your Mortgage Underwriting Gets Delayed
Final Thoughts: Should You Walk Away?
Walking away from an underwater mortgage is a major financial decision that should only be considered after exploring every alternative. For some, it may be the best option—but for many, solutions like loan modification, short sale, or renting out the property offer better long-term outcomes.
