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Incredible, But True February 7, 2008

Posted by davidzweig in economics.

Troubled borrowers are walking away from their homes – Feb. 6, 2008

Walking away from a six-figure mortgage will do less damage to a person’s credit rating than would missing a few credit card payments. This latest manifestation of the Law of Unintended Consequences reveals the foolishness (and some would say the avarice) of the credit card side of banks that helped draft the revision of the bankruptcy laws a few years ago.

How severe is the problem? In San Diego, 56% of home sales are now foreclosures or REO (Real Estate Owned), meaning the mortgagor has taken over the house because the owner walked away.

The presence of a foreclosed or REO home meaningfully depresses the value of nearby homes that are still occupied. The writedown by the bank is almost always vastly greater than the charged (probably Chinese) merchandise on the credit card. And yet, as in so much of the current economy, incentives are in exactly the wrong place to get us out of this predicament.

There is more reason to believe this will spread, than there is reason to believe it will not. This, from CNN:

…while a mortgage default can savage a person’s credit record, trying to pay off a loan they can’t afford could be worse for borrowers if it leads to bankruptcy, said Craig Watts, a spokesman for the credit reporting firm Fair Isaac.

Credit scores are hurt much more by missing multiple payments – on credit cards, cars and so on – than by a single foreclosure.

“The time it takes to regain your credit score [after foreclosure] can be shorter than after bankruptcy,” said Watts.

It typically takes three years of a spotless payment record after a bankruptcy before credit scores recover enough for someone to think about buying a home again, he said. After abandoning a mortgage, a person may be able to buy a new house in two years or less.

And now skipping out on a home is easier, thanks to the Mortgage Debt Relief Act of 2007. Previously, if a bank sold a foreclosed home for less than the mortgage balance and it forgave the difference, the borrower had to pay tax on that difference as if it were income. Now the IRS will ignore it.

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