Upside Down Mortgage

An upside-down mortgage is a mortgage where the home – owner owes more on the mortgage, than the market value of the house itself.

This is a situation in which one in five home-owners find themselves today, and have to take a decision between continuing their mortgage payments or walking away from their homes.

Most people who are in such a situation continue to pay the mortgage if they have the resources to do so.

This is because of the sunk cost – both financial and emotional.

On an emotional level a family gets attached to the house that they live in and are usually reluctant to leave it. Most of my friends and relatives who are in this situation don’t want to dump their home just because it lost its value.

This surprises me a little bit because these are the same people who flipped about two or three houses in the last few years, and now don’t want to leave a house behind just because it lost its value.

On a financial level, if someone has already spent about 100k on their house – they don’t want to book that loss. They try and pay the remaining amount in the hope — that someday they will be able to sell the house at a higher price.

Interestingly, even Warren Buffet commented on upside-down mortgages in his annual letter to Berkshire’s shareholders, and said that most people stop paying a mortgage because they lose their jobs and are not able to meet the monthly payments, and not because the house is worth less than the mortgage on it.

There are several people who talk about the morality of walking away from a house because it has lost its value and chide home-owners who are contemplating walking away.

I think that it is perfectly sensible to walk away from a house if it is– under water – both in terms of money and in terms of morality.

Lenders who made such mortgages knew perfectly well what they were doing and were only doing so because they were able to securitize these mortgages and sell them off to investment bankers and such.

The Investment Bankers were really the most sophisticated of the lot and should have understood the risk that they were taking. If they didn’t understand the risk and made trades that went sour – in no way does that make it the moral responsibility of the home owner to bank roll them when they themselves have lost a lot of money.

What do you think about the morality of walking away from an upside down mortgage?

2 thoughts on “Upside Down Mortgage”

  1. DG – I think the answer is clearer for people who didn’t have to put anything down.

    There is no way people who are down 200k or something can be expected to stay on with their homes.

  2. Buffet and many others fail to realize how bad things are in CA. People have lost 60% of their value in the past 18 months and the market is still going down. A lot of people in CA didn’t have to put any money down. Many people around here are walking away including myself. Obama’s plan will do little to help someone like myself with an LTV ratio of 220%. I’d like to stay in my house, but I can’t justify it economically when I’m 200k upside down and the house likely won’t recover for well over a decade.

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