Saturday, October 1, 2011

Foreclosure Dilemma

I've spoken to many people lately about the prospect of abandoning their home given the current housing market and economic situation. 

The problem with this kind of decision is that often the options are clouded by uncertainly.  In addition, the [left-wing] media has a vested interest in keeping the housing market "up" as long as possible.

In order to make the right decision; dismiss the morality!  It's incredibly difficult in the Obama economy to find the moral high ground (by design).  Not to mention that defaulting on a mortgage is not necessarily a violation of good faith, provided the collateral (the house) is surrendered in the same condition it was in when the loan was closed when the bank had an opportunity to properly evaluate the property (appraisal).  I will be dismissing the morality arguments in this post.  I also will not cover recourse laws, which vary state-to-state--consult an attorney before making any decisions.

Do the Math

Consider your housing needs in a rental situation and compare the costs to ownership.  Do not consider the potential for future appreciation as those costs are only realized when 1.)  the market improves and 2.) the home is sold.

If you need a minimum a two bedroom apartment, shop around and determine the prices.  In my area the monthly rent for a two bedroom starts at $900/month. 

Calculate in the tax advantage of ownership.  Multiple the amount of annual interest paid by your tax rate.  If you pay $12,000 a year in interest, and have an effective tax rate of 15%, your annual tax advantage is $1800, your monthly tax advantage is $150.

The total cost of renting a two bedroom apartment, to a previous homeowner, is $1,050 in my area.  Compare this number to the monthly mortgage payment.  Also consider the difference in utilities and maintenance, which tends to be cheaper in rentals.

Then there comes affordability:  Can you afford the home?  Can you afford to cut back in other areas to absorb a short-term hardship instead of surrendering the home?

Consider the Non-Economic Costs of Renting

Renters are often subject to many nuisances; noise, crime, parking, rules, etc...  The more economical a rental is, the more likely you will experience distruptions.  Consider the imposition of these nuisances on you and your family.  Will the kids have to switch schools?   Will you be able to sleep without constant noise and disturbances?  Will you have to carry groceries up three flights of stairs?  If the landlord increases rent, will you move?  How much money and time will moving cost?

Does the current home meet your needs?  Will a rental?  If you outgrow a rental the only option is to move when the lease is up and rent another home which will likely cost more.

Although difficult to put a monitory number on these kinds of issues, it may be worth the extra $200-400 a month to own a home v. renting to avoid them.

Future Risk

As much as homeowners are underwater, the amount of debt and mortgage payments may pale in comparison to the future cost of housing.  A fixed rate mortgage is also a fixed housing expense.  Renting / future home ownership costs will vary based on the economy and interest rates.

If a homeowner is underwater $20K in his mortgage, which requires a  fixed payment at $1,700/month, that may be cheap compared to the future costs of housing.  Yes, it may actually be cheaper to accept being underwater and making a fixed mortgage payment!

No one knows what the future will hold, however, many economists have openly stated that the only way to manage our current $14T in debt + unfunded liabilities will be inflation.  Higher inflation will bring higher housing costs and higher overall costs of living.  The smartest thing to do in such an environment is to fix as many expenses as possible.

For a window into our future, look at Europe.  In the UK, home ownership is nearly impossible unless a home/home equity has been inherited.  100 year mortgages are the norm an assumable.  A 30 year mortgage would seem like a gift in that market!

Credit Scores

There is a ton of information out there about how foreclosure impacts one's credit score.  To me, this is not an issue as a credit score can always improve with time and other factors.  Again, lots of info in this department.

Of more concern is that lenders are asking if a foreclosure ever occurred.  Three months ago, 10 years ago, doesn't matter.  Having a foreclosure on your record will impact your ability to get a mortgage in the future and your costs.  Realize that a slight interest rate increase, because of a foreclosure, may very well offset the advantage of walking away from an underwater home. has calculators that can help anyone understand the total cost of a mortgage.  Paying just a 50 basis point (0.50%) penalty for a foreclosure on your record can cost you tens of thousands of dollars over the life of the loan!


It can be very troubling to see your home's value plummet on Zillow, but that only shows you part of the picture.  This is very complicated situation and it isn't helped by the uncertainty in the housing market and the overall economy.  The most important thing one can do is to keep his head on straight and consider the long-term, as well as the short-term consequences.

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