Time to bite the bullet: Foreclosure is inevitable for many homeowners

The Wall Street Journal reports today that just as the Obama housing rescue plan gets underway, many banks are increasing their number of foreclosures. JPMorgan (JPM), Wells Fargo (WFC), Fannie Mae (FNM), and Freddie Mac (FRE) have all ended their self-imposed moratoriums on foreclosures and are moving aggressively to deal with failing accounts.

According to a study commissioned by the Boston Federal Reserve, unemployment and falling real estate values are larger factors in foreclosures than interest rates. If this study is correct, then foreclosures and evictions are almost a certainty for many families. After all, if a homeowner is simply unable to make payments on a home, then refinancing, lowered interest rates, and other supports are merely stopgaps. Taken another way, they become painful delays, dragging out a torturous process.

Once we move past the question of "if" foreclosure will happen, the issue becomes "when." The general consensus is that keeping distressed homeowners in their houses is generous and moral. After all, nobody wants to get forced out into the street, and losing a home -- and a dream -- is brutal. However, in truth, it might be in the best interests of many homeowners to quickly and cleanly end the pain. In those cases where buyers' eyes were clearly bigger than their wallets and no amount of financial wizardry will resolve their distress, there is a lot of value to accepting reality and moving on. Doing so sooner rather than later enables them avoid the credit damage (and emotional distress) caused by eviction. More importantly, a clean break can also help them begin the next step in their lives. They can begin to rebuild credit, take steps to live within their means and, in general, stop living with the sword of Damocles (or the foreclosure of Wells Fargo) hanging over their heads.

Moving on gets even easier when it comes with a pocketful of cash. In many cases, foreclosing companies and "other real estate owned," or REO, brokers have been offering distressed homeowners cash incentives for leaving their houses without a fuss. These "cash for keys" deals seem to be a win-win situation: For the foreclosed homeowners, this money can help them cover moving expenses, short-term rent, and other essentials. For the bank, cash-for-keys helps speed up the foreclosure process, discourages vandalism, and can generally make everything a little easier.

Ironically, the party that might be most damaged by a foreclosure is the bank. By resolving the question of an asset's market value, the bank firmly establishes the worth of its holding. In this market, a foreclosed property is almost sure to represent a financial loss. Writing it off likely will damage the balance statement, further weakening the bank's position.

Moreover, the drop in asset values can, across the board, further depress the real estate market, doing considerable damage to all of a bank's holdings in an area. Taken to its extreme, a rash of foreclosures effectively creates -- or at least exacerbates -- a vicious cycle of reduced values and increased foreclosures, which can destroy a bank or make its survival dependent on more bailout money. As experts estimate a 22 to 27 percent drop in home values since January, this will have a significant effect on the very institutions that are setting this process in motion.

As Wells Fargo, JPMorgan, and their colleagues contemplate future foreclosures, it behooves them to move slowly and thoughtfully, as the dreams they're crushing may well be their own.

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