When to Consider Foreclosure
A mortgage is a loan secured with the value of the property purchased with the loan. If the borrower fails to pay the mortgage, the lender has the right to foreclose on loan, take ownership of the property and sell it off to recoup their losses. Foreclosure is often viewed as purely negative from the perspective of borrower, but in some cases, choosing to walk away from a mortgage and face foreclosure can be a sound financial decision.
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Negative Equity
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Negative equity is one of the primary reasons borrowers walk away from mortgages and accept foreclosure. Negative equity (also called being "upside down" or "underwater" on a mortgage) occurs when the amount you owe on the mortgage exceeds the value of the home. For instance, if you owe $100,000 on your mortgage and your home is only worth $90,000, you have negative equity. In this case, you should consider going into foreclosure because it will allow you to avoid paying your lender more than your home is worth.
Buying Too Much Home
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Another circumstance where you may benefit from considering foreclosure is if you take out a mortgage on a home that you have to stretch yourself financially to afford. Many homeowners buy homes that require them to commit a third of their income or more toward mortgage payments, which can be financially restrictive over time. It can be difficult to save for retirement, education, vacations and luxuries when servicing an expensive mortgage.
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Interest Rate Hikes
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Many homeowners choose to take out adjustable-rate mortgages (ARMs.). ARMs often have attractive short-term interest rates, but rates can increase over time after the initial periods of low interest rates end. You may benefit from walking away from a mortgage in response to a large hike in your interest rate that makes your home more difficult to afford.
Considerations
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Deciding to walk away from a mortgage and enter foreclosure makes financial sense if you have little or no equity in your home. If you have equity in a home, you will likely be better off selling the home than going into foreclosure. Borrowers that make large down payments on mortgages are less likely to face negative equity and will be less likely to benefit from going into foreclosure.
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