The Domino Effect of Foreclosure
You may be scanning the economic news with discomfort and wondering to yourself, "How does the housing market create a recession?" You might view a downturn in the housing market as an effect of recession -- as jobs become scarcer and both lenders and individuals become more conservative with their spending, there would be fewer buyers out there looking, bringing prices down.
Also, as more and more homeowners lose their jobs, they lose the ability to make their monthly mortgage payments. This hurts lenders' ability to extend credit to others, and the people who own homes around foreclosed properties see their own property values decline.
A drop in property value may not seem like a short-term issue for homeowners who are not looking to sell anytime soon. In fact, the reduction in value can lead to lower property tax bills each spring.
The hidden domino effect has to do with equity. If you've been paying your 30-year note faithfully for five years, the truth is that you don't have a whole lot of equity in your home yet. The vast majority of your payments, in the first few years of your loan, go to interest. If you're not making extra principal payments, you're not building up much equity.
So, if your property value plunges, you can end up upside-down (owing more than your equity is worth). This can make your lender very nervous, raising the likelihood of foreclosure proceedings if you fall a few months behind. And so one foreclosure can lead to many others in the same neighborhood during a recession.