Earn What You Spend

Underwater mortgages are easy to understand: they occur when a homeowner owes more on their house than what they could get if they sold the house.  That is, the outstanding mortgage is greater than their home value. 

But they are very interesting and consequential phenomenon, especially considering a large number of those who are underwater on their houses put down a down payment (meaning the home value has fallen further than their down payment, which is significant).  Let’s look at an example:

Say three years ago you bought a house for $250,000.   You, unlike most of your neighbors at the time, put down a 20% down payment of $50,000.  So your mortgage is for $200,000.  Now imagine this house is located in Mountain House, California, one of the most underwater towns in all of America.  The value of your property has dropped by about 35% and your home is now worth $162,500.    So just like that - having done everything “right” and followed the prescriptions of the housing experts by putting down 20%, not getting an adjustable rate mortgage - you now owe about $40,000 more to the bank than your house is worth. You’re underwater.

Now some people, of course, can ride this out.  If this theoretical house was bought for the long-term, and you didn’t plan on selling it until you retired thirty years later, this blip in housing prices would not matter much.  

But not everyone is so lucky.  What if you lost your job and could no longer afford the mortgage payments?  This is increasingly common with the fall in employment.   You’d be forced to sell an underwater house.  What if your job was transfered to a different state, and you either moved or lost it?  You’d be forced to sell an underwater house.  Medical bills rising and you need to downsize to a mortgage you can afford?   You’d be forced to sell an underwater house.

In writing about this in previous posts, I underestimated the negative implications of being underwater on a mortgage.  I thought being underwater on your house didn’t matter that much if you a) didn’t need to sell immediately or b) did not have an ARM.  It turns out there are lots of reasons people sell their homes, and they are not all by choice (unless you consider moving to keep your job a choice; I think of it as a forced hand).  It is a crisis. 

Source: NYTimes

This infographic from the NYTimes shows the story quite well. Look at places like Nevada and Michigan which have 48% and 39% of their homes, respectively, underwater.  Home prices continue to fall pretty dramatically, which only exacerbates this trend.  Let’s hope they stabilize sometime soon.