New Twist on Centuries-Old Law Offers Underwater Homeowners Hope

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Underwater mortgageGovernment has long used its powers of "eminent domain" to seize private property for projects it considers in the "common good," like roads or schools. Two cities in California, however, are putting a new spin on this centuries-old law, one that may help get besieged homeowners out of their underwater mortgages not only in California, but across the country.

But first, the inaugural cases have to make it through the courts, and that's not going to happen without a fight.

Help for the Drowning Homeowner

The Wall Street Journal reports that the idea is to use eminent domain to seize the distressed properties, pay the lenders off at a price agreed to by the courts, then resell the property back to the original homeowner at a fair market value.

Homeowners are said to be "underwater" or "upside down" on their mortgages if they owe more on their homes than the homes are worth. The two California cities considering this groundbreaking application of eminent domain are Fontana and Ontario, both of which are in San Bernardino County, the nation's 12th largest county by population. More than 40% of homeowners there are upside down on their mortgages.

Just Slip Out the Back, Jack

When homeowners are underwater, there's always a danger they might decide to just "walk away" from the house, take the credit-rating hit, and go start over somewhere else. Of course, they wouldn't be able to buy again immediately, but they might be able to rent. Regardless, it gets them out of a frustrating or unsustainable financial situation -- one that can also put the municipality into a similar situation.

Abandoned homes drive down neighborhood property values, potentially putting more homeowners into financial binds, which can persuade even more of them to pick up and go. This is what officials in Fontana and Ontario see happening in their towns and are trying to reverse or at least halt.

California: An Ideal Testing Ground

The thought of having an upside-down mortgage suddenly turned right-side-up is an undoubtedly happy one for homeowners, but not for the original lenders, who foresee their balance sheets being decimated by substantial reductions in monthly mortgage payments. That's because the program is not aimed at defaulters, with whom the banks may have had to negotiate for a reduction in payments anyway. For homeowners to qualify for this new plan, they will have to be current on payments.

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As such, once the first of these eminent-domain property seizure cases go to court, the banks will fight back vigorously. And as this is the first time anyone has tried to use eminent domain in such a manner, it's impossible to say how the courts will rule, though some have their guesses.

Carrying out these seizure-resell processes will require that municipalities team up with private investors, which will help facilitate as well as profit from the deals. The Journal reports that at least one such partner, Mortgage Resolution Partners out of San Francisco, is optimistic: "California legal precedent and political posture," the company has stated, "favor the program and constitute an ideal proving ground."



Like, a Totally Radical Solution, Dude

Politically, culturally, and economically, much of what the rest of America eventually gets around to doing begins in California. If this plan by the leadership of Fontana and Ontario succeeds, it could affect up to 3 million homeowners for starters. After that, who knows? Such a strategy could even be a way for the rest of the country to extricate itself from its housing mess.

It's not often the government comes up with an "ingenious rescue plan," and the dysfunctional nature of California's politics in general argues against the genesis of this one, yet here it is. With some of the worst foreclosure rates in the nation, California may have helped lead the rest of the country into the housing bubble, but now at least it may be helping to lead it out.

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Top 10 College Towns for Buying Foreclosures
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New Twist on Centuries-Old Law Offers Underwater Homeowners Hope

For real estate buyers who have the cash and credit to take advantage of historically low mortgage rates, there is one market type that tends to be more resilient than others: the college town.


Established, big-name universities, with their steady and ever-replenishing supplies of new students, faculty and administrators, virtually guarantee tenants and future buyers. Additionally, more retirees are choosing to move to college towns for the cultural amenities. Of course, the downsides for home buyers, particularly investors, are that renting in college towns is a somewhat seasonal business, with a summer decline, and there's always the threat of keg-party damage.


Foreclosure sales data compiled by Foreclosure News Report for the first half of 2011.

The College Town of: Stanford University


Amount of properties sold: 94


Average price of foreclosures: $350,886


Percent below the average price of properties: 69%


Percent of foreclosures from all home sales: 17%

The College Town of: Ohio State University


Amount of properties sold: 999


Average price of foreclosures: $57,700


Percent below the average price of properties: 58%


Percent of foreclosures from all home sales: 17%

The College Town of: University of Louisville


Amount of properties sold: 889


Average price of foreclosures: $84,495


Percent below the average price of properties: 51%


Percent of foreclosures from all home sales: 25%

The College Town of: Northwestern University


Amount of properties sold: 74


Average price of foreclosures: $190,930


Percent below the average price of properties: 47%


Percent of foreclosures from all home sales: 24%

The College Town of: Louisiana State University


Amount of properties sold: 221


Average price of foreclosures: $115,043


Percent below the average price of properties: 45%


Percent of foreclosures from all home sales: 14%

The College Town of: University of Arizona


Amount of properties sold: 3,068


Average price of foreclosures: $116,916


Percent below the average price of properties: 41%


Percent of foreclosures from all home sales: 50%

The College Town of: University of Tennessee


Amount of properties sold: 431


Average price of foreclosures: $108,595


Percent below the average price of properties: 41%


Percent of foreclosures from all home sales: 8%

The College Town of: Florida State University


Amount of properties sold: 339


Average price of foreclosures: $112,790


Percent below the average price of properties: 35%


Percent of foreclosures from all home sales: 29%

The College Town of: Texas Tech University


Amount of properties sold: 74


Average price of foreclosures: $91,454


Percent below the average price of properties: 33%


Percent of foreclosures from all home sales: 5%

The College Town of: University of Michigan


Amount of properties sold: 130


Average price of foreclosures: $181,766


Percent below the average price of properties: 31%


Percent of foreclosures from all home sales: 24%

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John Grgurich is a regular contributor to The Motley Fool.
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