What is an Underwater Mortgage?
If you read the news at all, you've probably seen the term "underwater mortgage," but do you know that that means? When a mortgage is underwater, it means that the homeowner owes more on the mortgage than the house is actually worth.
That's not supposed to happen. In fact, from roughly 1990 to 2006, no one seriously thought that underwater mortgages were ever going to be a big problem. We all believed that housing prices would just keep rising and that we could count on our building equity to give us all the other cool things we wanted. Like fancy cars, a new deck, or a guaranteed retirement.
Welcome to reality! What happened instead is that mortgage lenders got pushed into writing more mortgages to more people by the federal government in the 1990s, the banking industry got greedy. Mortgage lenders wrote increasingly questionable mortgages for people who obviously wouldn't be able to afford their payments.
They created ARMs, a mortgage product that offers a sweet low rate up front interest rate, but then resets to reflect inflation after 1-7 years, depending on the terms you got, and keeps resetting every year after that.
And guess what happened? Exactly! Those bad mortgages started going bad in droves starting in 2007. At the same time, the mortgage lenders had sold those mortgages in bundles with false labeling, so the businesses that invested in those mortgages suddenly started losing money hand over fist.
And, voila! We had the recession and near-financial collapse of 2009.
Guess what else happened? Suddenly there was a glut of houses on the market from all the foreclosures that happened when the people who got those bad loans couldn't pay them. What happens when supply goes way up? Demand falls way down—and so do property values.
Add 10% (or 17%, if you understand how the government isn't showing you accurate unemployment numbers) unemployment into the mix, and what we have on our hands now is a mess where a quarter of US homeowners have underwater mortgages—and one out of ten of them owe 25% more than their houses are worth!
Clearly this is a tough situation for homeowners who need to decide whether it makes more sense to keep paying on their underwater mortgage or to strategically default, just as any business does when it's faced with an underwater investment.
It's a hard situation for neighborhoods when houses are getting boarded up and trashed because of foreclosures—which just drags property values down more.
And it's hard for city governments as they're losing all of that tax revenue from property taxes.
But if you're dealing with an underwater mortgage, the first people you need to look out for are yourself and your family. If you decide to walk away and strategically default on your mortgage, you could end up staying in your house rent-free for possibly up to 2 years.
This way everyone wins a little. You keep maintaining the house so the mortgage lender doesn't have to. You may need to keep paying the taxes during that time, but that helps keep city services going. And your neighbors won't have to take a hit on their property values while you're waiting out your default period. You may even be able to negotiate a short sale with your lender so the house is never empty!
And while you're staying in your house payment-free, you can save up for your life after your foreclosure or short sale. In other words, you won't be throwing good money after bad.
In a nutshell, then, an underwater mortgage presents homeowners with tough decisions. No one is going to completely win here. But you can get out with most of your finances intact and be a small help to your neighbors and community while you're doing it. So, really, if you're in an underwater mortgage this is not a life-or-death situation—unless you let it be one.
That's not supposed to happen. In fact, from roughly 1990 to 2006, no one seriously thought that underwater mortgages were ever going to be a big problem. We all believed that housing prices would just keep rising and that we could count on our building equity to give us all the other cool things we wanted. Like fancy cars, a new deck, or a guaranteed retirement.
Welcome to reality! What happened instead is that mortgage lenders got pushed into writing more mortgages to more people by the federal government in the 1990s, the banking industry got greedy. Mortgage lenders wrote increasingly questionable mortgages for people who obviously wouldn't be able to afford their payments.
They created ARMs, a mortgage product that offers a sweet low rate up front interest rate, but then resets to reflect inflation after 1-7 years, depending on the terms you got, and keeps resetting every year after that.
And guess what happened? Exactly! Those bad mortgages started going bad in droves starting in 2007. At the same time, the mortgage lenders had sold those mortgages in bundles with false labeling, so the businesses that invested in those mortgages suddenly started losing money hand over fist.
And, voila! We had the recession and near-financial collapse of 2009.
Guess what else happened? Suddenly there was a glut of houses on the market from all the foreclosures that happened when the people who got those bad loans couldn't pay them. What happens when supply goes way up? Demand falls way down—and so do property values.
Add 10% (or 17%, if you understand how the government isn't showing you accurate unemployment numbers) unemployment into the mix, and what we have on our hands now is a mess where a quarter of US homeowners have underwater mortgages—and one out of ten of them owe 25% more than their houses are worth!
Clearly this is a tough situation for homeowners who need to decide whether it makes more sense to keep paying on their underwater mortgage or to strategically default, just as any business does when it's faced with an underwater investment.
It's a hard situation for neighborhoods when houses are getting boarded up and trashed because of foreclosures—which just drags property values down more.
And it's hard for city governments as they're losing all of that tax revenue from property taxes.
But if you're dealing with an underwater mortgage, the first people you need to look out for are yourself and your family. If you decide to walk away and strategically default on your mortgage, you could end up staying in your house rent-free for possibly up to 2 years.
This way everyone wins a little. You keep maintaining the house so the mortgage lender doesn't have to. You may need to keep paying the taxes during that time, but that helps keep city services going. And your neighbors won't have to take a hit on their property values while you're waiting out your default period. You may even be able to negotiate a short sale with your lender so the house is never empty!
And while you're staying in your house payment-free, you can save up for your life after your foreclosure or short sale. In other words, you won't be throwing good money after bad.
In a nutshell, then, an underwater mortgage presents homeowners with tough decisions. No one is going to completely win here. But you can get out with most of your finances intact and be a small help to your neighbors and community while you're doing it. So, really, if you're in an underwater mortgage this is not a life-or-death situation—unless you let it be one.
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