Can You Walk Away From a Mortgage and Rent a Home?

Recourse, One-Action and Non-recourse Loans

Some states limit the actions lenders can take to collect on a defaulted loan. In California, for example, non-recourse regulations ban lenders from holding borrowers personally liable for any deficiency after a foreclosure sale. New York is an example of a one-action state that allows lenders to take a single action against borrowers who default – they may sue or foreclose but they can’t do both. Most states are recourse states that allow lenders to seek a deficiency judgment after foreclosure. A lender uses a deficiency action to sue a borrower for the difference between the proceeds of the foreclosure sale and the amount the borrower owes on his mortgage. Even in recourse states, however, lenders may make non-recourse loans limiting themselves to repossessing or suing for the default. Research your state laws governing foreclosure and review your mortgage contract carefully to find out what your lender's options are and to assess their potential consequences for you.

Your local market conditions might make it possible for you to rent a home that's comparable to your own or even better than your own for considerably less than you're paying on your mortgage. If so, and you're in a non-recourse or single-action state or you have a non-recourse loan, the difference between your mortgage payment and rent is found money you can save or use to pay down other debt. In this sense, strategic default can be a means to a fresh start.

The most immediate impact of walking away is that your credit score will take a whopping hit. Precisely how big a hit depends on your current score. The higher it is, the bigger the impact. The foreclosure will keep you from qualifying for another mortgage for at least two years. It may carry serious tax consequences as well, as the IRS counts the forgiven debt as income and taxes it accordingly. A low credit score will affect your ability to borrow for any reason for years to come, and it may affect job applications and limit your choices of rental homes. You’ll have much less stake in your rental home than you do in the home you’re walking away from, so you’ll have to work to convince prospective landlords that you’ll honor your lease. Finally, foreclosures have a negative impact on their neighborhoods. In areas where foreclosed homes comprise a significant share of the market, they drive down the values of surrounding properties.

Landlords' primary concern is whether or not they'll be paid. The first step toward convincing your prospective landlord that you will pay is to make responsible use of the money you save when you stop paying your mortgage. Although you can count on staying in your home for four to five months, in many areas of the country it takes many months and sometimes well over a year for homeowners to be forced out. Use that time to save first month's rent, last month's rent, a security deposit equal to two months' rent and, if possible, two to three additional months' rent that you'll pay in advance. The advance rent payments protect the landlord if she needs to evict you for non-payment, so be prepared to offer enough in advance to cover the time it takes for a landlord to evict in your city. In the meantime, stay current on all of your other bills. You'll have a difficult time convincing a landlord that you can afford to pay rent if you had late bill payments despite not paying your mortgage.