By Shirley Pulawski

Over the last few years, since the crash of the housing bubble and in this troubled economy, many homeowners have homes worth significantly less than what they paid, greatly diminished incomes, and other issues. Foreclosing on a home has major ramifications that can last for years, but for some, foreclosure may seem like the only option. Here, we take a look at some of the details and alternatives.

Many Americans bought homes during the housing bubble which are now worth much, much less than the asking price at the time. There are many reasons home prices have fallen, resulting in underwater mortgages. As an example, entire neighborhoods were built in a booming frenzy by construction companies during the bubble. In some of these areas, the construction created a glut of housing, and many houses stayed vacant. The homeowners who bought into these ghost towns are faced with empty neighborhoods and homes valued at far less than what they owe. Other more established neighborhoods emptied out as homeowners defaulted on sub-prime mortgages, causing homes in the entire neighborhood to fall in value. The homes are hard to sell, even at a loss, and can be just as hard to rent out to others.

And it’s no secret that incomes around the country have dropped. Most everyone knows someone who has lost a job and taken a pay cut upon returning to work. Mortgage payments which were easy to meet under better wages have now become increasingly harder to pay, and many homeowners are finding themselves struggling to stay on top of the bills.

So, while some bought homes they couldn't quite afford, lured by low interest rates and all-too-willing, unscrupulous lenders and they ended up in default. However, for many Americans, home purchases that seemed like a wise investment at the time have turned into financial disasters. Many are wondering what to do next with a mortgage that is too high, homes that won’t sell for enough to pay for the mortgage, or homes which are simply unlikely to sell at all.

Foreclosure is one way out of the game, but with steep implications. It can completely destroy one’s credit rating for years to come, and make it difficult to get a needed loan later on. It could hurt a family’s chance of renting if a credit report is part of the applicant screening process, thereby limiting rental options. Any open lines of credit may be lowered once the default goes on record, and some credit card companies may change other terms. Further, there can be steep tax implications come April 15.

If a homeowner is already behind on payments, these ramifications may already apply.

The advantages of foreclosure include being able to stay without paying rent for a while. In some states, this could be a year or longer, which could buy time to catch up financially, find better employment, or otherwise develop ways to increase income. During that time, it might also be possible to negotiate new terms with the bank, especially if the home is in a difficult housing market. However, we’ve all heard the horror stories about cut-throat practices by some lenders who have foreclosed on homes illegally, so it is still very risky.

An alternative to foreclosure is a short sale, although the negative impact to credit scores can be just as bad as a foreclosure on record. A short sale is an agreement with the bank to sell the house for less than what is owed, and the homeowner can be allowed to walk away with minimal cost, or given terms to pay back the deficiency which the homeowner can more easily handle financially.

Often, people facing these difficult choices are advised to seek other alternatives. If it’s possible to secure more affordable living quarters (perhaps with a family member, for example), renting out the house can be an option bring in income and avoid foreclosure. However, this route can bring its own problems as well, especially if the tenants prove to be troublesome. The home will still require maintenance and homeowners fees.

While advice to rent the home out can be thrown around liberally and by people who mean well, it's not always an option. Some homeowners associations may have restrictions on renting, or it may even be banned, so it may not even be possible to rent the home. Even without a homeowner’s association, many municipalities have laws which restrict rental terms. For example, in many college towns, year-round residents have worked to pass laws that keep homes from becoming college flop houses by encouraging local government to pass laws allowing no more than two unrelated adults to live in one single-family home, or similar laws. Research on local laws will be required to determine if renting is actually an option.

Of course, none of these tips can replace legal advice from a qualified lawyer. Laws vary greatly by state and region, and the unique set of circumstances any homeowner is in vary as well, so there are no simple solutions when the mortgage has turned into a monster. Foreclosure can be a way out from under an enormous burden, but not without long-term consequences. It’s important that anyone considering foreclosure consider all the options open to them and seek the advice of qualified professionals.

Related Articles
  1. Home & Auto

    Top 6 Mortgage Mistakes

    These common errors could end in foreclosure.
  2. Professionals

    Helping Clients Navigate Short Sales And Foreclosures

    Both buyers and sellers can benefit from a real estate professional experienced in dealing with short sales and foreclosures.
  3. Home & Auto

    Don't Let Foreclosed Homes Ruin Your Neighborhood

    Empty homes in your neighborhood aren't just eyesores - they can affect the value of your property.
  4. Home & Auto

    Investing In Foreclosures Not A Get-Rich-Quick Venture

    Investing in this kind of real estate takes capital, time and careful planning.
  5. Home & Auto

    Your Mortgage: When It's Time to Walk Away

    Mathematically speaking, walking away can sometimes be the most prudent choice. Find out how to run the numbers.
  6. Credit & Loans

    Understanding Home-Equity Loan Rates

    Shopping is the most important part of getting a home-equity loan. You're going to have to live with the terms for a long time.
  7. Credit & Loans

    5 Signs a Reverse Mortgage Is a Bad Idea

    Here are the key situations when you should probably pass on this type of home loan.
  8. Credit & Loans

    5 Signs a Reverse Mortgage Is a Good Idea

    If these five criteria describe your situation, a reverse mortgage might be a good idea for you.
  9. Credit & Loans

    Guidelines for FHA Reverse Mortgages

    FHA guidelines protect borrowers from major mistakes, prevent lenders from taking advantage of borrowers and encourage lenders to offer reverse mortgages.
  10. Home & Auto

    The Pros and Cons of Owner Financing

    Details on the upside and risks of this type of deal for both the owner and the buyer.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Chattel Mortgage Non-Filing Insurance

    An insurance policy covering losses that result from a policyholder ...
  3. Zombie Foreclosure

    A situation (or a home in this situation) that occurs when a ...
  4. Fair Housing Act

    This law (Title VIII of the Civil Rights Act of 1968) forbids ...
  5. Deficiency Balance

    The amount owed to a creditor if the sale proceeds from the collateral ...
  6. Total Annual Loan Cost (TALC)

    The projected total cost that a reverse mortgage holder should ...
RELATED FAQS
  1. What is foreclosure investing?

    Foreclosure investing involves the purchase of houses that are somewhere in the process of being confiscated by lenders due ... Read Full Answer >>
  2. What is a subprime mortgage?

    A subprime mortgage is a type of loan granted to individuals with poor credit histories (often below 600), who, as a result ... Read Full Answer >>
  3. How do I calculate how much home equity I have?

    Even though it is normally assumed most people know their home equity, many are still confused about the topic. It is an ... Read Full Answer >>
  4. What is the difference between "closed end credit" and a "line of credit?"

    Depending on the need, an individual or business may take out a form of credit that is either open- or closed-ended. While ... Read Full Answer >>
  5. In what instances does a business use closed end credit?

    The most common types of closed-end credit used by both businesses and individuals are mortgages and auto loans. Businesses ... Read Full Answer >>
  6. What are the typical requirements to qualify for closed end credit?

    Typical requirements for a consumer to qualify for closed-end credit include satisfactory income level and credit history, ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!