Crushing debt, lost jobs and slower city services such as police response times are all indicative of financially troubled, and sometimes bankrupt, cities. But they shouldn't prevent new home buyers from getting a home loan and moving in, some borrowers and lenders say.

In fact, if you want to follow the investing adage of buying low and selling high, then buying a home in Detroit, Stockton, Calif., or any other city that has filed for bankruptcy or has similar financial problems, you're more likely to find a deal there, says Keefer Virden, who with Rodney Watts bought two homes in Detroit in 2008 as investors and now rent them out.

"Detroit is on the upswing right now," says Virden, 43, a lifelong resident of Detroit. "Detroit is not going to be the same Detroit 10 or 15 years from now."

Bankruptcies remain rare

Detroit is the largest city in U.S. history to file for bankruptcy, with $18 billion in debts. Since January 2010, there have been 37 municipal bankruptcy filings, with only eight by local governments and most from utility authorities and special districts.

Bankruptcy filings are related to many debts, with the most common being city worker pensions that can no longer be afforded.

Some financially troubled cities are worth watching for problems such as budget deficits, bond downgrades, high amount of violent crime, and poor investments.

Effects on neighborhoods

Home values typically fall more in financially troubled cities, and foreclosures are more common, says Scott Anderson, chief economist for Bank of the West in San Francisco. In the California city of Vallejo, which declared bankruptcy in 2008 and emerged from it three years later, home prices dropped 67 percent after bankruptcy was declared, Anderson says.

"It really affects the economic environment of the metro area," he says, adding that along with lower home prices, bankrupt cities face more lost jobs and less income for residents.

Such cities also cut services such as road and sign repairs, and police and fire response times can lessen, causing more people to leave.

"Detroit may never come back to its former glory, just for the prospect of more people leaving the area," Anderson says.

How home loans affected

Bankrupt cities are more at risk for home loan defaults and foreclosures, Anderson says. But that doesn't mean that banks are less likely to loan there, says Cyndee Kendall, Bank of the West's Bay Area and Northern California regional manager for mortgage.

"A mortgage loan application is approved based on the potential borrower's credit and ability to pay. The financial health of a city doesn't factor into the underwriting process," Kendall wrote in an email response.

"Where a municipal bankruptcy could come into play is in the appraisal process, if homes are not selling or values are declining," she says. "But that's an appraisal issue."

"If a city bankruptcy filing brings home prices down, it could actually be a good time to buy," she says.

For Watts, the real estate investor in Detroit, getting a bank loan is difficult as an investor.

"The banking industry sucks because they're not doing any lending to me now," he says.

"Its gotten so crazy right now, if you're late paying a light bill, it affects your credit," Watts says.

How bankruptcy can help a city

Despite all of the national reporting on how bad Detroit is, "the only thing that's lacking is police presence," says Virden, the real estate investor there. But cities that go through bankruptcy can improve, he says.

Vallejo, for example, emerged from bankruptcy two years ago and seems to have become a stronger community, says Janet Perry, who with her husband bought a foreclosed home there in 2009, a year after the city's bankruptcy filing. Local business owners seem happier to have customers, Perry says.

They bought their home for $360,000, getting a bargain on a home that had a $750,000 outstanding loan balance before it was foreclosed. Perry says they had no problem with their bank in buying the home.

Their neighborhood on Mare Island is isolated from the main part of the city, and while violent crime has been decreasing, Perry says she doesn't count on a quick response from police for non-emergencies. She has an alarm service form a local business for her home, a service that she says many of her neighbors have.

"We can't depend on the police to necessarily be responding," she says.

"If I have an emergency, I call our alarm company," says Perry, a needlepoint teacher and writer from her home business. "I don't even try to call the police because I know they won't even answer promptly."

While some home buyers will benefit from picking over the carcass of Detroit and buying cheap homes, the best way to get bankrupt cities back on their feet and have people want to live there is to add jobs, says Anderson, the economist.

"People want to see light at the end of the tunnel," he says.

Published on September 6, 2013