Monday, October 12, 2009

Home Value Less Than Your Mortgage Balance?

Home Value Less Than Your Mortgage Balance?
 Are you in trouble? Generally speaking, this is absolutely untrue! I understand this may sound contrary to what you have been programmed to think, but here is the financial fact:

Home values – including yours – are determined by market forces. The value of your home depends on real estate market conditions, so as a homeowner, there is absolutely nothing you can do about the ups and downs in the values.

There are those who think – wrongly – that if they aggressively pay down their mortgages and build a lot of equity (the value of a house less the mortgage balance), their home values will somehow be “enhanced.” Sadly, some in the financial profession condone and teach this illusory and completely out-of-touch-with-reality concept.

When home values drop or increase in an area by, say, 20 percent, all homes in the area experience the same loss or increase. In other words, the balance of someone’s mortgage is completely irrelevant here.

For instance, let’s assume Karen and David are next door neighbors with Marvin and Laura, and the couples have identical homes, valued at $350,000. Let’s also assume that Karen and David have a mortgage balance of $170,000, meaning they have $180,000 in equity (their home’s value of $350,000, less their $170,000 mortgage balance). Marvin and Laura, on the other hand, have $70,000 in equity because they still owe $280,000 on their home. Now, if values were to plummet by 20 percent, for example, the drop would affect both couples’ home values in the EXACT same manner. Karen and David would not escape that hit; neither would Marvin and Laura experience a heavier hit.

The idea that you will somehow escape or experience a lesser hit to your home’s value if you have a lot of equity in it is simply incorrect. Let’s look at this situation from two perspectives:

Homeowner’s Perspective

At least to this point, as long as you keep making your contractual payments, your lender cannot ask you to pay up because the value of your house has fallen to a level that is less than the balance owed. Have you heard of anything like that occurring since the Great Depression era, when mortgages were callable? Of course not!

So, you don’t have to worry about the value of your house, as long as you continue making your payments. Even if you do worry, you are frankly wasting your time and energy because worrying will do absolutely nothing to change the value of any piece of real estate you might own.

As a Lender

This is a bad position to be in, because the value of your clients’ collateral (in this case, their house) is less than the mortgage loan. Someone owes you $280,000, and the amount you can recover should they default is only $120,000. Oh, and in case you were wondering why certain people you know who haven’t been paying their mortgages for waaay more than 90 days still haven’t been foreclosed on, yet others were hurried into foreclosure beginning on Day 91, check out how much equity each of them had. You’ll likely discover that those in the latter example had a lot of equity – which, from the lender’s perspective, is called profit.

If you were a lender, wouldn’t you teach homeowners to strive to eliminate their mortgages quickly and aggressively? The reason? So YOU (the lender) will have a safe profit margin in the event that your borrowers become unable to make their payments for 90 conservative days and you have to foreclose.

So you see, it really depends on which side of the bargain you are. My opening answer to the question of whether or not you should be freaking out was “Absolutely not!” because I was addressing the issue from the homeowner’s perspective.


  • Don’t purchase an overpriced house. I know people who, a few years back, bought homes they clearly knew were overpriced. Some even offered more than the asking price. But you know what? This is America, so you can pay whatever you want, regardless of whether it makes sense.

  • You would be smart to hire a savvy financial professional to help you to successfully manage your home’s equity, so that you remain in control and ensure that your home is paid "for" in the smartest, most appropriate, and tax-efficient manner.
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