Underwater Mortgage: Should You Hold Or Fold?

By Lisa Smith | December 03, 2009 AAA
Underwater Mortgage: Should You Hold Or Fold?

On a national basis, it seemed like real estate prices did nothing but rise from the time the United States was founded until the crash of 2008. In reality, the past has seen national declines in minuscule amounts, but the collapse seen in 2008 was a nightmare that still hasn't ended for many homeowners. Today, one in four residential mortgages are held by would-be homeowners who owe the bank more than their homes are worth. The deeply indebted consumers now face a tough choice: hold or fold?

What Happened?
Relaxed lending standards encouraged many people to buy homes. Rising property value encouraged many homeowners to refinance in order to take cash out of their homes. When the real estate market heated to a boil, more than a few buyers put down little or no money in terms of a down payment when they made their purchases. When the bottom fell out of the real estate market, 11 quarters of consecutive declines in home values through to the third quarter of 2009 shaved off about 22% off of the value of those homes according to Zillow's Home Values Index. On a $400,000 home, that's nearly a six-figure decline. For the once-proud owner of that castle, the result is a $90,000 reduction in equity that likely caused the homeowner's mortgage to go into negative equity. According to Zillow, 21% of American homeowners with single-family homes were still underwater in the third quarter, compared to 23% in the second quarter. (Learn more in Who Is To Blame For The Subprime Crisis?)

Even on less expensive homes, the numbers are daunting. A report from real estate information provider First American CoreLogic indicates that: "The average mortgage debt for properties in negative in equity was $280,000 and borrowers that were in a negative equity position were upside down by an average of nearly $70,000." It's a common scenario, with 10.7 million households holding mortgages for amounts greater than the value of the homes that serve as their collateral. Since the first quarter of this year, Zillow reported home price declines in the second and third quarters as well.

Walking Away
What do you do when you are in the red? For an increasing number of homeowners, the answer is walk away. While a significant number of the more than 10% of unemployed Americans are unable to pay their mortgages, even those mortgage holders that can afford to make their payments are choosing not to make them. According to "Understanding Strategic Default in Mortgage", a joint study released by Experian and Oliver Wyman, more than half a million borrowers chose to default in 2008 even though they didn't have to take that path. That's more than twice the number of borrowers who willingly walked away from their homes in 2007.

It's a trend that is likely to continue. A new report, "The Vulnerable Middle Class: Bankruptcy and Class Status", which was provided to USA Today suggests that college-educated homeowners will continue to face challenging times. It's part of an ongoing trend whereby America is Losing The Middle Class.

What to Do
So what do you do if you find yourself underwater? If you plan to live in the property for the long term and can afford to make your payments, make them. Over time, real estate values are likely to improve. Paying off your mortgage early is also a good strategy to stem your losses, as every penny spent on interest is a penny wasted. Retiring your debt also puts you in a stronger financial position by freeing up your cash flow. (For further reading, check out Homeowners, Beware These Scams and Avoiding Foreclosure Scams.)

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