Should I Stop Making Mortgage Payments?

Considering strategic default in a Texas bankruptcy

For many Texas residents, their home is not just a place to live, but an investment. Unfortunately, like all investments, homes run the risk of loss. Over the lifetime of the typical 30-year mortgage, property values in the area may fall dramatically, leaving the homeowner with an outstanding mortgage debt that exceeds the fair market value of their home. In addition, a sudden change in personal fortunes (e.g., a loss of employment or an unexpected illness) can leave the homeowner unable to afford the monthly mortgage payments on their now-underwater home.

Can a Texas Lender Seek a Deficiency Judgment?

So what are the homeowner's options? In many cases, the best option may be to intentionally stop making mortgage payments. Even if you can afford to keep doing so in the short term, a “strategic default” may be more advantageous in the long term. In other words, rather than continuing to pay into a worthless investment, you can redirect your monthly mortgage payments into a less-expensive rental home, pay down other debts, or perhaps even build up your savings.

Of course, a strategic default is not quite that simple. Even after the lender forecloses on the underwater property, Texas law permits it to seek a “deficiency judgment” against the former homeowner. The deficiency represents the difference between the “fair market value” of the property and what the lender is able to obtain at a foreclosure sale.

For example, say you have a $300,000 mortgage on a house that is now worth only $200,000, and you decide to make a strategic default. The bank forecloses and only gets $180,000 at auction. The bank then turns around and asks a judge to issue a deficiency judgment against you.

But how much is the deficiency? Remember, it is not what you owed on the mortgage, but rather the fair market value of the property when you defaulted. In the above hypothetical, the market value was $200,000 at default, and the lender received $180,000 at auction, so the deficiency you would be liable for is only $20,000.

Now the lender may dispute your appraisal of the fair market value of the property—after all, it is a subjective determination based on a number of factors, including the overall state of the housing market in your area. For this reason, you may need to consult with an experienced Texas bankruptcy attorney who can help you defend a contested property valuation.

Can Filing for Chapter 7 Help?

Bankruptcy is also an option if you are faced with a deficiency judgment that you cannot afford to pay. In a Chapter 7 bankruptcy, most (if not all) of your unsecured debt is liquidated. This includes a deficiency judgment, since it represents that portion of your debt that is no longer secured by the house, which has already been sold.

Keep in mind that both strategic default and filing for Chapter 7 bankruptcy will have a serious negative impact on your credit. Not only will your credit score drop, but, if your mortgage was backed by Fannie Mae, you will not be eligible for another government-backed loan for seven years following your foreclosure. And even if you plan to just rent going forward, a landlord will likely review your credit report, and may reject your application based on past history.

For more information on this area of law, see our bankruptcy overview.

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