Home foreclosure

How to cope with the crisis next door

Todd Ballenger, Founder, National Institute of Financial Education

Even though today's economy is showing signs of recovery, the foreclosure crisis is expected to continue. This is for a number of reasons, but job loss tops the list. Since it will be a while before the job market stabilizes (current projections show this happening in the third quarter of 2010), consumers will have to cope with the continued backlash, including foreclosures.

One of the unfortunate dynamics of home foreclosures is that their impact is widespread. They directly affect the homeowner, the foreclosed property and the mortgage lender, while indirectly impacting the value of surrounding homes and potentially the financial well-being of family members who provide assistance to displaced relatives. Whether you’re facing the direct or indirect ramifications of a foreclosure, you need to know the facts.

Indirect impact #1: Reduced home value because of a neighbor's foreclosure

It's all about location, location, location. When a neighbor goes through a foreclosure, your home's value could be reduced in a number of ways. First, if the foreclosed home is comparable to your own, and sold at a discount to fair market value, your home's value could also take a hit. Or if your neighbors are forced to sell their house in a bank trustee sale, which can be as much as 30% below current market value, your home's value could go down comparably.

Your home value can also be affected if a neighboring foreclosed property remains unoccupied for months — and starts to show it. In today's environment, foreclosed properties can take months, even years, to get back on the market, with banks unable to keep up with the huge volume of shuttered properties. In the meantime, these homes can become vulnerable to a number of risks, including deterioration and even criminal activity, which can ultimately affect your home's value.

What you can do about it

Although you may not be able to control some of these factors, such as the reduced sale price of a neighbor’s home, you can at least take actions to address the appearance of the property:

1. Read the foreclosure notice posted on the home's front window or door, write down the contact information and maintain it for future reference. You never know when you might need this information.
2. Contact your local police department and ask them to put the home on their watch list. This may help deter any criminal activity, such as break-ins.
3. Reach out to local officials to check into your rights to clean and water the yard. Even though the previous owners may be required to take care of the property, their actual efforts at upkeep could be minimal.
4. Ask the bank if they will cover the costs for maintenance. They may be willing to pay you for your time or at least reimburse you for any charges you incur (e.g., fuel for your lawnmower, water bills).
5. Based on your rights to care for the property, collaborate with your neighbors on a plan to monitor the home and to maintain its curb appeal. For example, set up a rotating weekly schedule indicating when each neighbor will watch and maintain the property. This includes monitoring the house for activity (and reporting anything unusual to authorities), as well as mowing and watering, removing newspapers, and picking up abandoned mail and litter.

By making the vacant home look lived in and tidy, you can help maintain your home’s value and also keep your neighborhood safe.

Indirect impact #2: Need to support family members experiencing foreclosure

Your foreclosure risk is no longer as simple as not being able to make your own mortgage payments. It now extends to others you know, who may turn to you for support if they lose their homes. According to an AARP analysis of U.S. Census data, this decade has seen a 25% increase in the number of arrangements with multiple generations living under one roof (excluding two-generation households with parents and their children under age 18).¹

Foreclosures are contributing to this trend, with many well-prepared individuals now having to take in relatives or offer them financial assistance. This can result in family turmoil, caused by the strain of numerous households living under one roof, as well as reduced cash flow because of increased grocery costs and the need to offer additional financial support.

What you can do about it

If you are in a position to assist financially, try to help your family members avoid foreclosure by agreeing to pay for some of their expenses until they get back on their feet. This can help your family members in the long run, too, because their credit won't be tarnished for the typical 7-10 year period following a foreclosure.

If this isn't an option and you instead invite your family members into your own home, try to set ground rules early on. For example, determine how you'll divvy up grocery expenses and assign household chores. Also, try to agree on timelines for your extended family's next steps, such as when they will be ready to seek alternative housing.

While the indirect impacts of a home foreclosure can be significant, the direct consequences are even more substantial — both emotionally and financially.

Direct impact #1: Loss of shelter and lifestyle

Two thirds of U.S. homeowners have a mortgage — a monthly payment on the principal and interest for their home (as well as mortgage insurance when required). Depending on how the mortgage payment is set up, it may also include an escrow to cover property taxes and homeowners insurance.

Most mortgages offer a 15-day grace period, which means that if the payment is received within that extended time period, no late fee will be assessed. However, once a payment is 30 days late, it will result in a late fee and hit the mortgage holder’s credit report. And at 60 days late, the lender may begin taking legal action.

It's estimated that one in 10 U.S. homeowners with a mortgage has exceeded the 60-days late threshold and is at risk of foreclosure.² (About one third of all U.S. homeowners don’t have mortgages and simply need to keep up with their state property tax payments to remain in their homes.)

Homeowners who are 60 days delinquent can expect calls and letters asking that their payments be brought current or face foreclosure. However, as of Oct. 1, a new consumer protection law allows a clerk of court to suspend the house foreclosure process for another 60 days if they believe the homeowner and the lender could work out a resolution. While there is no guarantee, anyone coping with a foreclosure that originated on or after Oct. 1 should at least ask the clerk of court for this extension.

What you can do about it

Anyone who is nearing foreclosure should take the following steps:

1. Find out who the lender is by calling the number on the monthly statement (even though mortgage payments may be serviced by one party, a second party could be the actual lender).
2. Contact the lender and clearly explain the situation, and ask to take advantage of any government or bank program designed to help people avoid a house foreclosure. One source for this information is the Federal Reserve website.
3. If these options don’t work, ask for a deed-in-lieu of foreclosure. This is when the homeowner voluntarily gives up his or her house to the bank to avoid the legal expenses and larger credit impact of a full foreclosure proceeding.

If none of the above solutions works, the formal foreclosure process would begin, which can take an average of six months from the date of the initial notification from the lender to the time the homeowner is forced to move out.

Direct impact #2: Loss of house-related wealth

For many people, their home is one of their most valuable assets. The main source of that wealth is the equity in their home. If a house has a current market value of $300,000, and the current mortgage balance is $250,000, the homeowner has $50,000 in current house-related wealth. But if they can't make payments and end up in foreclosure, they will likely lose this equity — especially if the lender tries to sell the house as quickly as possible by discounting the price.

Bank-owned houses are being sold at a significant discount to fair market value — in some states as much as 30%. So if a $300,000 house is sold at a 27% discount, for example, it could net as little as $219,000 at a bank trustee sale. On top of the lost home equity for the homeowner, this could result in a shortfall to the bank of $31,000 on a $250,000 balance owed. Add average legal expenses of $5,000 and the homeowner could end up owing the lender closer to $36,000, plus any back payments and interest expenses. The lender can then place a "deficiency judgment" on the homeowner for these shortfall expenses, which could remain on their credit report for up to 10 years.

What you can do about it

If the lender pursues a deficiency judgment in court, they could be awarded a levy against other real property the homeowner owns. For example, if the homeowner loses an investment property through foreclosure, the court could place a judgment on his or her primary residence. This means the homeowner would be unable to sell that property without a court release and could be required to repay the outstanding debt for the investment property through the sale of the primary residence.

However, if a husband and wife jointly own the primary residence (both of their names are on the deed) and the judgment is only entered against one of them, that judgment will not affect any real property that is in both of their names. So if, for example, only the husband was listed on the judgment for an investment property, a judgment could not be entered against a jointly-owned primary residence where he and his wife are listed on the deed.

Many house foreclosures today involve little to no equity. The actual financial loss for homeowners in this situation is more likely to be in the future, through increased costs to borrow and reduced access to credit.

Direct impact #3: Impact on future borrowing

A house foreclosure is estimated by Fair Isaac (now known as FICO) to reduce a credit score by 200 to 300 points on a primary residence, and about half that on an investment or second home. That means an excellent credit score of 750 today could be reduced to a score as low as 450 after a foreclosure. Any score below 620 will dramatically increase the cost of borrowing in the future. General impacts of a foreclosure on credit can be found at myfico.com.

A foreclosure can also impact borrowing capacity. Many items that would normally be easily financed will require larger down payments with higher interest costs. These higher costs could last 2-7 years depending on the status of the homeowner’s current credit and ability to rebuild credit worthiness. Much of this borrowing incapacity is the result of the 2-10 year waiting period required by most lenders before new property financing can be extended to a consumer after a foreclosure. In addition, if a judgment was awarded for the bank shortfall, legal expenses and other costs, it can remain on a credit report for 10 years and will have to be paid in full before new property financing can be secured.

What you can do about it

Anyone who is nearing foreclosure should consider the longer-term negative impacts — from reduced credit scores, judgments and future borrowing capacity — and seek alternatives such as government-sponsored programs or assistance from family members. This is why it's essential to take precautions earlier on. Refinance to a lower interest rate. Establish a home equity line of credit for increased cash flow. Set aside at least six months' worth of living expenses in a cash reserve.

As the economy improves, foreclosure rates will eventually follow suit. In the meantime, foreclosure isn't the only option for struggling homeowners. If you have questions about how a foreclosure could affect your financial future — either directly or indirectly — your Ameriprise financial advisor can help.

Todd Ballenger is author of Borrow Smart, Retire Rich. He is also the founder of the National Institute of Financial Education (niofe.org), which offers a series of video classes and materials on the Making Home Affordable program as part of the Financial Red Cross program.