With falling housing prices in nearly every market, the questions that homeowners are asking have shifted. Instead of asking “what is my home worth?” they are now asking “Is my home worth it?”
These problems are affecting the entire country, with nearly 1 in 6 homeowners owing more than their home is worth. For homeowners who owe more on their loan than their home is worth, they are placed in a precarious position. Reports suggest that nearly 12 million homes are “under water” (see Reuters), which is double the amount from last year and continues to grow.
In particular, borrowers may have negative net value where the appraised value on the home is worth less the net remainder on the loan. Furthermore, the values of these homes may continue to fall while payments increase. As a result of these unsettling trends, an increasing number of homeowners are looking at all of their options.
Drive by a neighborhood today, and there’s likely a few “For Sale” signs prominently displayed. The influx of houses on the market is a product of shifting economic conditions more than anything, and recent surveys suggest that many of these homeowners won’t be able to sell their homes for as much as the principal on their mortgage.
It can be a difficult economic decision when faced with an “underwater” mortgage, although certain banks have shown more of a willingness to alter the terms of the original loan than others. Still, the lender’s decision to renegotiate is entirely voluntary. You should always first pursue this option of communicating with your lender before making any unilateral decisions.
If you’re faced with negative home equity, then you might consider “walking away” from your home. But before you make that decision, it’s important to analyze the costs and benefits as well as the possible alternatives.
In order to make an informed decision, it’s important to distinguish between book value (the difference between liabilities and assets) and equity (which incorporates potential future improvement in the situation.) Today, many companies operate with heavy debt burdens, often giving them a negative net book value (not sound financial practice, but not too uncommon either), while they still have positive equity in the eyes of the market.
How can this be the case? Well, if you anticipate that an adjustment in the terms of the loan or an improvement in the value of the underlying asset can shift the equation, then you may still have positive equity in your home.
When making a decision to walk away from your home, consider the long-term implications of your decision in terms of future scenarios as well as the impact upon your credit before making a final choice. Just as millions of homeowners now face negative net book values (Yahoo News), there are also investors who see long term values as the market improves.
So, while it might be the right decision to walk away in the short run, you should weigh all of the trade offs before making that decision. Walking away from your home will impair your credit, making it difficult to get another mortgage in the near future. Your lender may also pursue a deficiency judgment or attach wage garnishments to your future income.
The main reason why you shouldn’t be so quick to walk away from your home mortgage is that the market is indeed undergoing a shift. Particularly important, is the fact that government intervention may help homeowners to achieve improved terms on their mortgages.
But that help is yet to be seen and impossible to measure…
Further, banks are more willing to modify loans today than they historically have been, given the fact that they realize having “underwater” mortgages on their books doesn’t benefit them. The problem is that most loan modifications entail a rate reduction but very few lenders offer any kind of meaningful principle reductions.
The bottom line is that if you took on a home loan that you couldn’t afford in the past, then you probably should make an honest evaluation of your finances and move forward within your means. You may be able to realize a deed in lieu of foreclosure, which can help protect your credit relative to a default, while allowing you the opportunity to rebuild your credit.
However, most lenders require that a borrower attempt a short sale prior to entertaining a deed in lieu. Often, lenders require that the home is on the market for 60-90 days before allowing negotiations to start in regards to a deed in lieu of foreclosure.
The negative real equity positions that millions of homeowners are holding has become central in the recent financial collapse, as well as the government’s efforts to re-capitalize lending institutions which made these loans. A common criticism of the Economic Recovery plan is that it has benefited banks without helping individual homeowners.
While the FHA Hope for Homeowners program does address principle reductions, it leaves write downs voluntary for mortgage servicers. This problem seems to be the thorn in every single program and initiative that has come out of Washington and until the mortgage servicing issues are addressed properly, critics say, that these plans will not work for Main Street.
America is “underwater” and millions of homeowners need a mortgage life raft or they are simply going to bail out of their sinking homes. The government must face and address the decline in income along with the decline in the underlying value of the homes in our country.
Take the example of Stockton, a medium sized town in California. In recent years, home prices rose rapidly, and buyers were eager to purchase long-term mortgages which lenders provided, even to those with marginal credit scores. As a result of these loan decisions and the deterioration in market conditions, the majority of new homeowners in the region are now considered to be “underwater.” In fact, the city recently was named the nation’s largest source of home foreclosures with over 8,000 homes being foreclosed this summer alone (see Business Week).
This trend is not an aberration, however, as the city has had among the highest rates of default for the entire calendar year. As a result, nearly half of the homes in the city are owned by banks, which will have to write down the value of the homes as a result.
These problems are definitely not restricted to Stockton. They are affecting the entire country, with nearly 1 in 6 home owners owing more than their home is worth.
Given the financial difficulties, it can be hard to find a loan to refinance in our current market. This gives homeowners few options short of loan modifications, short sales, bankruptcy, deeds in lieu of foreclosure or government assisted intervention. If you look at recent figures, however, the situation appears even bleaker. For those who have purchased homes in the past five years, nearly 30% owe more than the principal on their loan (see Wall Street Journal).
As a result, a swift market correction is taking place, with homeowners looking to government officials to help ease the transition back to a point of equilibrium.
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