To Foreclose or Not To Foreclose

by Odysseas Papadimitriou on January 13, 2010

foreclosureA recent article in the San Francisco Chronicle offered an interesting opinion by Brent T. White, a law professor at the University of Arizona.  He advises homeowners to allow their home’s to go into foreclosure when they find that their home is worth less than what they owe on their home loan.  His argument is that foreclosure is a smarter economic decision and that it is only the social stigma of losing one’s home that is keeping homeowner’s paying their bills when it would be in their best interest to cut their losses and run.

I agree with White that there are times when it is in a homeowner’s best interest to simply walk away from their loan.  However, I also feel that he grossly misrepresents the repercussions of a foreclosure. White’s suggestion completely downplays that, in most cases, creditors can still legally pursue you.  He also suggests that one’s credit score after going into foreclosure is likely to recover in two years.  The truth, however, is that you will have bad credit for the next 5 to 7 years, which means limited access to credit and increased costs on anything that relies on your credit history (e.g. renting an apartment).  Finally, White’s suggestions ignores the human cost of this stressful process.  Going through foreclosure creates a great deal of anxiety.  It is not something you can simply do without feeling the effect on your own well being.

With these likely repercussions in mind, before making the decision to walk away from a home loan,  homeowners should take a realistic assessment of their home’s value and the likely impact of their foreclosure on their lives. Two elements should factor heavily in this decision:  your ability to pay your bills based on your income and the likelihood of your home appreciating in value.

First, can you afford the monthly house payment with your current income?  This question is central.  If you are significantly dipping into your savings in order to pay your mortgage then you are simply staving off the inevitable. If your ability to pay your mortgage is unsustainable, be proactive about the inevitable.  Start planning before the foreclosure.  Don’t give your savings over to a lost cause.  By planning ahead, you can maximize the resources available to you after the dust clears and you are through the foreclosure.

Assuming that you can afford your mortgage payments with your income, your decision to go into foreclosure should be directly tied with the appreciation that is required to make the value of your home greater than the value of your loan.  A home that requires 10 or 15% appreciation is likely to turn around soon enough that it wouldn’t make sense to suffer the effects of a foreclosure. If, on the other hand, your house requires a 100% appreciation to make your loan worthwhile then it is unlikely that it will turn around in the foreseeable future and continuing to make payments on such a loan may be a bad idea.  The homeowner would have good cause to consider simply walking away or doing a short sale.

Ultimately, unless your house has depreciated in value to such a degree that it is unlikely to be worth more than the amount you owe in the near future, or if you find yourself dipping into your savings in order to make house payments, you shouldn’t walk away.  The damage to your credit, your lifestyle, and your peace of mind  isn’t worth it.  However, if you find yourself in one of the two aforementioned situations (or both), then you may want to heed the advice of Brent T. White and consider the option of walking away after you consult a lawyer.

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