Homeowners Face the Reality of Negative Mortgages

Most of us are familiar with the idea of being upside-down on a car loan. This is the period, generally the first few years after one buys a new car, when one owes more on it than it is worth. This happens because the biggest depreciation hit on a new car happens when it is driven off the lot and is no longer new. However, it is also possible to be upside-down on a used car, especially if you still owed on your old car when you traded it in and the remaining balance on your old note was added to your new loan.

By contrast, people seldom considered the possibility of being in that situation with a house. Real estate doesn't experience depreciation the way vehicles and other movable properties do, since land doesn't wear out that way. Instead, it is generally expected that real estate will appreciate in value, and can be considered a long-term investment like stocks and bonds.

However, when real estate speculation causes prices to become detached from the fundamentals, the resulting bubble creates a dangerous situation. When it breaks, as all bubbles do, the going price of houses will drop back to a level in line with the fundamentals of that area's real estate market. As a result, homeowners soon discover that they owe more on their mortgages than the houses are worth. They're upside-down, or in the terms favored in the real estate industry, they have an underwater mortgage. This problem was further exacerbated because a large number of people refinanced their homes to cash out the paper equity created by those inflated housing prices and used the money to pay for a lifestyle they couldn't really afford.

Particularly in California, this situation became so bad that the majority of homeowners in whole neighborhoods had underwater mortgages. Many of these homeowners are consumers purchased their homes at the peak of the boom, when prices had become completely detached from fundamentals and had nothing to do with the realities of housing in those areas. During that period home values in many of those areas doubled and even tripled within a brief time.

When the inevitable implosion came, many of these homeowners were left wondering what they should do. Should they try to keep making the payments and hope to recover the home's lost value, or should they bail?

That decision will depend at least in part upon the type of mortgage the homeowner has. Someone with a fixed-rate mortgage, especially at some of the extremely low rates that were available at the peak of the housing bubble, may be able to continue to pay their mortgage payments. However, people with adjustable-rate mortgages are often seeing them tick upward repeatedly as money becomes tighter, putting them in a worse bind.

If you can afford your monthly mortgage payments and have no other pressing reasons to relocate, you may be best off hanging onto your house and riding out the current troubles. Many market analysts believe that the market will bottom out and then recover as the economy in general begins to grow again. If the house itself is fundamentally sound and serves your needs, hanging onto it means that you will end up with a good investment in the long run.

Other homeowners have not been so fortunate. Many of them have had their livelihoods fall victim to the general economic contraction that followed the collapse of the housing market. Others have had to take jobs in other areas, often at lower pay rates. In such situations, they had little choice but to give up their former homes. Homeowners with adjustable mortgages often found that rising interest rates increased their monthly mortgage payments beyond their ability to pay.

Worse, many of these homeowners have discovered that their lack of equity in their homes will narrow their options if they try to sell. The amount of equity that a homeowner has in their home in the early years of a mortgage is often determined by the amount of their down payment. During the housing boom it was quite common for many buyers to purchase homes with very little, if any, down payment. At the time it was touted as enabling people to become homeowners who otherwise would have been stuck renting indefinitely. But when people bought homes at the peak of the bubble, they started at zero equity and rapidly went to negative equity when the bubble burst and housing prices went back in line with the fundamentals of the area's market.

As a result, they may have to bring money to the table in order to get their house sold, making up the difference between the selling price and the amount they owe on the mortgage. An alternative is a short sale, in which the house is sold for less than is owed and the lenders agree to accept less than is owed on the debt. This generally results in a black mark on the homeowner's credit report. However, that negative is generally less severe than the negative that results from a foreclosure.

Unfortunately, many homeowners have found themselves in such severe troubles that foreclosure became their only option. In some areas, the housing surplus was so extensive that it was virtually impossible to get anyone to buy it, even at a loss. In those situations, the only solution was to hand the keys back to the bank and find a place to rent. Some people have advised homeowners to drag the process out as long as possible, since many banks were so overwhelmed with non-paying mortgages that it would take them months or even years to actually file the foreclosure paperwork and begin the procedures to dislodge the former homeowner from the premises. This strategy would enable a family to live in the home cost-free for a number of months and accumulate enough seed money to rent some other place to live. However, other advisors have suggested that such a strategy does more harm than good, leading potential landlords to view the former homeowner as a deadbeat who cannot be relied upon, and that it is a better long-term strategy to come clean to the bank right away, surrender the keys and move out.

Because of the severity of the mortgage crisis and the sheer number of homeowners involved, the federal government established various programs to help homeowners keep the homes they'd struggled to own. The best known is the Home Affordable Modification Program or HAMP, which was intended to allow homeowners with underwater mortgages or who were significantly behind on their payments to restructure those payments to keep them in line with income. However, in practice there have been serious problems with these programs. There have been numerous allegations that banks and mortgage companies deliberately stalled and obstructed the process, losing paperwork repeatedly and using other tricks to pretend that the homeowner had failed to complete the requirements, and then went ahead and foreclosed. As a result, it appears that HAMP and similar programs have helped far fewer American homeowners than should have been eligible.

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