How Foreclosures Affect Home Values

A foreclosure is essentially a forced sale by the mortgage lender due to the inability of the borrower to continue to make payments on the home loan. There is widespread debate on the issue of how foreclosure properties affect neighboring home values. Some believe that there is little or no contagion effect, or simply that the presence of a foreclosure on your block does not negatively affect the value of your own home. Others think that it is hard to escape the virus of falling real estate prices once the first foreclosure sign goes up in your area. The truth is probably somewhere in between these two extreme views.

There are two major factors that may be responsible for a fall-off in home prices due to the prevalence of foreclosures in the neighborhood.

Buyer’s Perception of the Area Falls  

The first factor is all about perception. At the end of the day, the real estate market is simply a market and as such it is based on the perception of value. There are no concrete rules that set the market prices for real estate. A home is sold for an amount that is dictated by the trends in the market, which in turn is basically the price at which one party is willing to accept and the other is willing to pay. Since the market is so fickle anything that puts a stain on the perception of this value has the potential to shake prices. A foreclosure is a sign of weakness and is a red flag for many people because it signals that all is not well in the area. This can cause a dip in demand which of course leads to a definite fall in home prices.

Distressed Look of Foreclosed Homes Decreases Value

Secondly, foreclosed homes are generally allowed to deteriorate because lenders are not in the business of maintaining real estate, but of granting and servicing loans. For this reason homes that are on the foreclosure list usually show signs of neglect which further depresses home values in the neighborhood as buyers look around to the other homes on the block to form an impression of a property’s worth. When a family goes into foreclosure you can assume that they are also not in a position to pay for anything to be fixed on a property so they are sold “as is”, yet another reason for a fall in home prices.

Remember though that foreclosures are not ideal comparisons, so if you are looking to buy a home be wary when a real estate agent pulls comparative data for you to look at and foreclosure sales are included in the calculations. These sales create a false impression on a property’s true value because the effects are not lasting.