Sell Your House Or Let The Bank Foreclose?
October 24th, 2007Disclaimer: I am not a financial professional and this should not be taken as financial advice. I don’t own a house either. I am only discussing what I would do in a situation in which housing prices are dropping, supply is at an all time high, and I was facing a mortgage rate reset.
A while ago I talked recently about the financial and emotional aspects of buying a house, but in today’s market, it’s probably better to consider the decision to sell your house. Specifically, the decision to sell your house if you are having financial problems.
The situation that a lot of people are facing right now is one in which they face reseting mortgage rates that will increase their monthly mortgage payment above what they are capable of paying. The chart below is from an IMF report (pdf link) on world credit that I found through Dr Housing Bubble.
Not all of that is going to default, but if these numbers are any indication, a whole lot of people will be wondering what to do when they get their new higher mortgage bill.
It’s a tough situation. If housing prices were still rising, you could sell your house, pay off your mortgage, and be free and clear.
But housing prices are not rising, they are falling; in some cases drastically. There are really only two options:
Option 1: Sell you house
If someone is in danger of defaulting, they can sell their house. In today’s market they probably can’t sell it quickly or for as much as they paid for it. Since the purchase is recent, they probably have very little equity built up. Selling at a lower price means they are still going to owe the bank the difference between what they paid on the house and what they were able to sell for. That doesn’t include all the commissions and cuts that have to be paid, so it will actually be slightly more than that.
In other words, they are in the same position as they would be if they had rented, only they’ve been making higher monthly payments and still owe a sizable chunk due to the difference in prices. On the other hand, their credit isn’t absolutely terrible, since they avoided foreclosure.
Option 2: Cut and run
Instead, this hypothetical person could just stop making payments and let the bank foreclose on the house. Credit score would go down the toilet for several years, but they’d walk away debt free.
In fact, the result of this option isn’t that different from the first option: they are just exchanging the leftover debt from the difference between the buy and sell prices for a terrible credit score.
So then the question is how much debt is it worth incurring to avoid a bad credit score?
Maybe one of the personal finance bloggers could answer this question. I’m inclined to say that no amount of debt is worth it, and so the second option is an obvious better choice.
Sunk costs at play
Though there is some suggestion of people walking away from their houses (maybe from patrick.net?) , sunk costs are coming into play here in a big way. People will consider all the money they’ve already put into the house, and won’t want to lose that. In fact, the sunk cost effect is much stronger in this situation because of the emotions involved in the idea of owning your own house. The effect will be strong enough to keep most people from giving up on their house until they are forced to.
But if you’re facing certain foreclosure, whether now or a couple of years, and you won’t be able to sell your house for more than you bought it, it makes more sense to me to stop paying now (why sink more money into a lost cause?) and walk away.
qualifier: I don’t really know how the foreclosure process works. Are you still liable for whatever value the mortgage has that the bank can’t recover? If so then it doesn’t seem like it matters much what you do.
-zot
Support The Decision Strategist.Popularity: 70%
October 27th, 2007 at 9:32 pm
I’d probably do the same as you would. Just get it over with, walk away, foreclose. Many folks try to do a short sale but they fail to make it work and eventually they just foreclose anyway. It may be easiest to foreclose and just bite the bullet and move on.
October 28th, 2007 at 10:17 am
[...] Sell Your House Or Let The Bank Foreclose? @ The Decision Strategist [...]
October 28th, 2007 at 12:36 pm
@Digerati Life:
Glad to hear that a pf blogger thinks there is some validity to my thought process ;). It’s a tough situation with no good answer.
October 29th, 2007 at 9:35 am
This is an interesting post, especially because I am in a situation right now where I wish I could just let my property go because it is a money pit. It’s a rental property and I don’t have the money to fix it up to sell and I’ve had bad experiences with tenants. I do not own my own personal home, and don’t plan to go in debt ever again, except a mortgage. In this case, it seems that letting it go would be the better easier way than pouring more money into it, but I wouldn’t be able to buy a home for myself for a long time. I’d like your opinion.
October 29th, 2007 at 2:12 pm
@gt5879c:
First I should say that I am not an expert in any of this, so take my opinion with a grain of salt.
One thing I would check if considering just letting the bank foreclose would be if they can also take other things of value such as my car.
But if I’m facing certain foreclosure at a later date, then sinking more money into it seems like a waste.
On the other hand, if you can afford to make the payments until the housing market recovers and then sell it, maybe that would be best.
Good luck. It’s a bad situation to be in.
-zot
December 8th, 2007 at 6:28 pm
I wanted to find out more about foreclosure. If i would walk away and just lose what i have in it, would the lender come after me if they dont sell it for what i owed? How does that work?
December 10th, 2007 at 9:38 am
@Jill:
I’m no expert on foreclosures, but this link from Wikipedia might help. From what I have read, it appears that the property is repossessed and sold, and the proceeds of that sale go to satisfy the bank and other creditors. I don’t think they are able to then come after you for the difference, but again, I’m not completely sure and am not a financial expert. Let me know if you find out a definitive answer though. Good luck!
January 24th, 2008 at 8:02 pm
If my mortgage is due in Feb1 2008 and I dont pay it planning on doing a foreclosure, when wil the bank take over the house??? after how many days?
February 16th, 2008 at 6:19 am
@ig0r: I would talk to your bank. They should be able to tell you how long before they will foreclose, and may give you an extension if that is what you are looking for. Keep in mind that I am not a financial expert and you shouldn’t take my advice as such.
Good luck though.
August 3rd, 2009 at 3:29 pm
Is there a way you can foreclose in an honest way? Maybe let them know that you can’t afford it anymore and you want to give it back to them? Instead of just walking away?
August 18th, 2009 at 11:31 pm
I did a quick google search, and this post came up. Here is my situation. I put 30K down on a duplex that I bought 5 yrs ago in Minneapolis with a friend. She flaked and I had to pay 10K to get rid of her, so I am in 40K. I met someone and we now have two houses. I live on a street that has rerouted buses so the house shakes. If I sold it, I would maybe get 240 minus all commissions. It is a beautiful house that I have dumped money and soul into, but I am exhausted with a money pit and tenant issues? I have constant flight fantasies. Any suggestions? My credit score is 799. Would I be able to ever buy again if I walked? This is my first house. Needless to say, I am bitter at the entire banking/real estate industry that I could own a house worth 60K less than I paid for it 5 years later.
September 20th, 2009 at 6:32 pm
from my experience, the short sale is possible. i have completed one. from what i have read, i am one of the lucky ones. most short sales fail. as far as foreclosures go, if one quits paying their mortgage and waits for the sheriff to kick them out, it could take over two years! if one deposited all that money in the bank in the meantime, one would surely have a nice pile of cash built up. perhaps consulting a lawyer would help. they may be able to tie up the legal process and allow for more time in ones home!
October 21st, 2009 at 6:35 pm
I am in a situation where I moved 3000 miles away from a home I bought in a relationship that went south fast. I probably invested 10K overall in down payment and refinancing to get the ex’s name off. The house is in a part of the country I loathe, and will never live in again.
I do make enough money to hang onto the house…barely, and rent in my hometown(I already moved out of my home).
But, I can’t sell the house for anywhere near what I refinanced it, and renting is a nightmare from 30 seconds away, let alone 3000 miles.
So, I am planning on letting it go. I only have 2 years of payments into it, and it’s basically been cheaper than renting, without the deposits. And, I would have to come up with probably 5-10K or more to get it show ready to sell and settle at the table whenever it does sell. I see it as the above people do: a waste of money and effort on a bad investment in a place I only lived for a spouse. I’m almost a month behind, and if you miss ONE month, your credit score already takes that 150 point nosedive. So you might as well foreclose at that point since the score is already gone.
I hate losing my prime(not great but prime) level credit score, but it’s only temporary. And I will be able to show only the house was where I lapsed.
People can still get loans with a foreclosure. It’s not credit death, just coma.
And they can’t garnish wages or come after you since they hold the collateral. It’s really the new bankruptcy for a lot of us that made bad choices when our economy was supposed to last. And we were lied to by the government that real estate was such a great gamble when they were secretly setting all of us up for failure by lending to people who couldn’t afford their mortgages.
I’m not making it any better by what I am doing, but I am making it even for myself…a second chance without this elephant on my back.
March 18th, 2010 at 10:24 am
[B]gamerflex.com[/B]
Hi, How are you? If you want to have a play on some cool flash games then give us a visit now.
[URL=http://www.gamerflex.com][B]Free Online Games[/B][/URL]