The Corner

The Edification Tsunami & Underwater Homes

Heh, it turns out most — though certainly not all — readers agree with me so far. The biggest critcism is that I didn’t talk — at least not directly — about the effect on mobility. I think that’s an entirely fair and correct exception to my point. If you need to move for a job and that would require taking a 200K hit on your house — assuming you can’t rent it out — you’re in big trouble. But while I think that’s a very good example of how being underwater can be a big problem, it doesn’t really contradict my point that being underwater is in and of itself not necessarily calamitous.

Anyway, a smattering from both sides:

Pretend you live in a suburb of Detroit, just got laid off, but have you landed a great job in another state. The house you purchased two years ago for $500,000 is now worth $300,000. And you still owe $450,000. You’re screwed.

And:

Banker here – you are correct. The only problem is for people who have to

move, and can’t sell. But the big thing that bugs me is this – absent from

all this analysis, is an analysis of how much homes SHOULD cost – i.e. –

given average income levels in a certain area, what is the “proper” cost of

a home – no one ever talks about that.

And:

Dear Jonah,

You are generally correct. As long as your hypothetical home owner still has the same income, then the $600K mortgage will still be affordable no matter what the actual value of the house is.

There are two complications: 1. If a person has the kind of work that requires frequent relocations, being underwater would complicate matters. They can sell at a loss and keep their credit rating, but use up savings to make up the difference, or ‘walk away’ and become a bad credit risk. In actuality, they pass-up an opportunity and stay put in their old job. This hurts the economy as a whole since talent is not going to where it will be most productive. 2. Rising valuations allowed borrowers with ARM’s to refinance–or at least sell with enough equity to move to a less expensive home with their credit intact.

I think the real problem is that people are more rational than moral. If you are $100K underwater, then you will be better-off defaulting. Your credit score will take a hit, but you will be in the same level of house for $100k less and still have income to support a higher valuation. How you go about defaulting will have some effect on your credit rating too. You could just stop making payments and live rent-free for the 6 months it takes to get thrown-out by the sheriff, or you could contact the bank and let them know that 2 months hence you will be out of the place and make all payments up till that point. The bank isn’t going to be happy either way, but there are levels.

Best Regards,

And:

Well, your point is correct if your house is only mildly underwater. The neighborhood I live in California, average price got up to $485,000 and has now dropped to below $165,000. When my wife and I first moved in it was a nice neighborhood, it is now vacated and families of 10 are moving in next to us. You tell me, does it make business sense to pay a mortgage on something like that when we were deceived about the value of the home in the first place? And the reason the prices dropped so drastically is because banks decided to give anyone a loan, so when they all started defaulting it sent everyone’s prices into a major drop. That price will never come back, not in my lifetime. So yes, walking away is the best option even if we can afford the payments.

And:

Finally, someone (you of all people! kidding) with the same thought as me. Plunging home prices are only a problem if you’re looking to sell a recently-acquired house. If you’re not in the market to sell, what’s the big deal?

And:

Jonah,

Let the edification begin. I agree with your analysis regarding the value of homes falling below the mortgage. Real estate, after all, is an illiquid asset and quite difficult to sell easily unlike, say, a share of stock in a public corporation. Therefore, almost by definition, real estate is a long-term investment. So it is difficult to listen to the mainstream media to discuss ad nauseam how awful it is for a homeowner to carry a mortgage worth more than the actual home. If the homeowner has at least a five year time horizon (as he should), he shouldn’t worry too much about losing his money (unless he purchased his home in a particularly bloated housing market a la southern Florida or Las Vegas).

Nevertheless, banks have a large problem, mainly of their own doing. Banks drove the real estate frenzy not only by approving mortgages to people who otherwise could not afford the loan. But some of the banks sweetened the deal by offering non-recourse mortgages. Thus, if the homeowner defaulted, he could simply walk away free from the worry that the bank could reach his other assets (i.e., his stock portfolio, car, boat etc…) and force him to meet his obligations under the mortgage. I don’t know how many of these types of mortgages are floating out there. But if there are a lot of them and many homeowners walk away and willing to take a hit on their credit, then more – not less – “toxic” assets are going to be dumped on the bank’s balance sheet. That sort of scenario, if played out on a large scale, would not encourage more lending.

And:

Jonah,

Long-time reader, first-time responder here. I think the crucial

pivot-point in your take on the dip in housing values is whether there

was a significant down-payment along with the mortgage. Without having

your own money invested, “owning” is really more like “rent-to-own.” So

there’s hardly any upside to staying in that mortgage if the house is

under water, and it becomes more akin to breaking a lease than the kind

of shameful thing that a foreclosure once was. No-money-down was one of

the worst of the many bad innovations of the recent mortgage market.

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