Hidden costs of foreclosure and short sales

On a housing discussion board, a user recently posted that he is considering walking away from his house. It appears that he can afford the house, he just sees the values dropping and doesn't want to be on the hook for an unnecessarily high payment. He thinks he'll save money by renting, rebuilding his credit, and buying again later.

Lets set aside, for the moment, the difficulty of timing the market perfectly and the morality of reneging on a contract. Those are issues the homeowner in question will have to decide for himself. Let's focus solely on the hidden costs of foreclosure.

It sounds so easy - just walk away, mail the bank the keys, and move on with your life. It can even be lucrative, to a point - if the owner stops making payments and remains in the house until the bank kicks him or her out, there can be several months of, essentially, free rent. But what are the costs after the foreclosure is final?

Many owners in this situation - low equity/downpayment, payment resets coming (or here), and little incentive to keep paying on a depreciating asset - have poor financial management processes. They failed to plan for the future, to recognize the risks of buying at the upper edge of affordability, and to really face the prospect of price depreciation. Many failed to recognize the bubbliciousness of housing prices when they bought. This is a bit of a "live for today, tomorrow will take care of itself" approach.

That is not the mindset of "save for a rainy day". It is the mindset that finances the joys of new car ownership with a new car loan or lease, one that buys life's little (and big) luxuries on borrowed money and leaves saving for emergencies for "someday." It is a mindset that depends on debt to enjoy the lifestyle that is desired. What happens to the debtor after foreclosure?

Foreclosure's negative impact on credit impacts more than just homeownership. Borrowers with "universal default" loans face interest rate increases to 30% or higher when their credit rating drops from the foreclosure. Their interest cost can triple or quadruple - and few such borrowers can pay off the loan in full, let alone refinance for better terms. Even loans without a universal default clause can be impacted. Perhaps your car payment will remain fixed after foreclosure, but your next new car purchase will cost quite a bit more.

Renting can be quite a bit harder with damaged credit. As can insuring your car and apartment. Many employers use credit reports as a screening tool, and some employers consider poor credit to be not just a risk for financial malfeasance (embezzling to pay off strangling debt), not just a risk that the employee will need to "moonlight" to pay debts, but also a reflection of a person's character. An employee who reneges on a mortgage contract, the reasoning goes, will just as easily renege on an agreement with his or her employer; an employee who plays loose and easy with the mortgage company's money might play just as loose and easy with the employer's time, money, or clients. Certainly, security-clearance jobs are hard to obtain with risky credit, but even modest jobs can be lost to poor credit.

Then there's the what-ifs and the morale busters. Our subject poster from the housing board could end up a former homeowner, strapped with higher borrowing costs on existing consumer debt, unable to accumulate a rainy day fund, unable to buy a newer, more reliable car because the car loan would cost far too much. Might he become frustrated and unhappy, buying himself a new pick-me-up every time a little extra money comes his way, perhaps even borrowing more to finance it? What if he loses his job, or has a major illness/injury, or needs a major car repair? If he is already strapped, can a small catastrophe push him or her over the edge? Might he avoid needed medical care and end up sicker, unemployable? Might he have to leave a decent job a short drive away in favor of a terrible job on the bus route? Middle class in America is often one or three bad decisions away from working poor.

Should homeowners walk, take in a roommate, or take another job? That's for them to decide - but I hope they are deciding with eyes wide open, aware of the costs of "saving" money through foreclosure.