Yesterday there was a news article on MSNBC that claimed 1 in 6 now owe more on their mortgage then their property is worth. The article states

The relentless slide in home prices has left nearly one in six U.S. homeowners owing more on a mortgage than the home is worth, raising the possibility of a rise in defaults — the very misfortune that touched off the credit crisis last year. The result of homeowners being "underwater" is more pressure on an economy that is already in a downturn. No longer having equity in their homes makes people feel less rich and thus less inclined to shop at the mall.

And having more homeowners underwater is likely to mean more eventual foreclosures, because it is hard for borrowers in financial trouble to refinance or sell their homes and pay off their mortgage if their debt exceeds the home's value. A foreclosed home, in turn, tends to lower the value of other homes in its neighborhood.

Among people who bought within the past five years, it's worse: 29 percent are underwater on their mortgages, according to an estimate by real-estate Web site Zillow.com.

According to Zillow, our home is one of those that is currently "underwater" because it's estimated value has dropped $25,000 since we bought it according to their algorithms. Given that we bought our home last year I don't doubt that we are underwater and in fact I expect our home value to only go down further. This is because the disparity between median house values and median incomes is still fairly stark even with the current depreciation in the neighborhood.

Here's what I mean; according to Zillow the median household income in the area is about $46,000 while the median home price is around $345,000. This disparity is shocking when you apply some of the basic rules from the "old days" before we had the flood of easy credit which led up to the current crises. For argument's sake, let's assume that everyone that moves to the area actually pays the traditional 20% down payment even though the personal savings rate of the average American is in the negative. This means they need a mortgage of $276,000. Plugging that number into a simple mortgage calculator assuming a 30 year loan at 5.75% interest gives a monthly mortgage payment of over $1600.

Using the traditional debt-to-income ratio of 0.28 a person with $46,000 in gross income shouldn't get a mortgage that over $1100 because they are hard pressed to afford it. Using another metric, the authors of the Complete Idiot's Guide to Buying and Selling a Home argue that you shouldn't get a mortgage over 2 1/2 times your household income which still has us with around $150,000 being the appropriate size of a mortgage that someone that lives in my neighborhood can afford.

However you slice it even assuming a 20% down payment, the people in my neighborhood live in homes that they couldn't afford to get a legitimate mortgage on at today's prices. That is fundamentally broken. 

Things get particularly clear when you look at the chart below and realize that house prices rose over $100,000 dollars in the past five years. 

A lot of people have started talking about "stabilizing home prices" and "bailing out home owners" because of underwater mortgages. In truth, easy credit caused houses to become overpriced especially when you consider that house prices were rising at a much faster rate than wages. Despite the current drop, house prices are still unrealistic and will need to come down further. Trying to prevent that from happening is like trying to have our cake and eat it too. You just can't.

I expect that more banks will end up having to create programs like Bank of America's Nationwide Homeownership Retention for CountryWide Customers which will modify mortgage principals and interest rates downwards in a move that will end up costing them over $8.6 billion but will make it more likely that their customers can afford to pay their mortgages. I'm surprised that it took a class action lawsuit to get this to happen instead of common sense. Then again it is 8.6 BILLION dollars. 

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Thursday, October 9, 2008 5:16:00 PM (GMT Daylight Time, UTC+01:00)
"house prices are still unrealistic and will need to come down further"
in that case loss has to be recognized.
ace
Thursday, October 9, 2008 7:01:54 PM (GMT Daylight Time, UTC+01:00)
the median household income in the area is about $46,000 while the median home price is around $345,000.


Translation: A LOT of people are renting apartments.
Swashbuckler
Thursday, October 9, 2008 10:28:42 PM (GMT Daylight Time, UTC+01:00)
I still don't understand the mindset that says a high home price is a good thing. Sorry, a high price when selling translates to high price when buying on average, too. Expecting to borrow against market price gains seems just stupidly risky, and I can't believe how many people fell for it.

Meanwhile, my house losing value doesn't affect my ability to pay my mortgage- losing my job etc. does. Something doesn't add up.
George
Friday, October 10, 2008 5:08:43 AM (GMT Daylight Time, UTC+01:00)
You need to come to London. Where I live the average house price is £300,000. Emphasis on average. At today's rates that's $510,189. This is crazy. Somehow a better system needs to be figured out. Part of the problem is the people who run the system [they are reckless and they often get bumper bonuses, which in turn makes them more reckless]. Mega rescue packages and increasingly complex regulation [+ enforcement] will only defer the next meltdown.
Friday, October 10, 2008 6:27:28 AM (GMT Daylight Time, UTC+01:00)
Dare,

Very interesting post.

@George I think one of the points you missed in Dare's post was the fact that many people were given mortgages that they couldn't realistically afford...even if they kept their job and economic times were good. Lots of blame to go around. The people who took the loans, the banks that gave them, the investment firms that bought the mortgages and the government that green-lighted the banks to give the loans. All around the board. Apparently, greed is still not good.
John Walker
Friday, October 10, 2008 11:16:09 AM (GMT Daylight Time, UTC+01:00)
I work for a large financial institution that is in trouble, but is also trying to help folks out with their loans - converting ARMs to Fixed and so on.

I saw one customer's revised loan:
* Original property value: $300,000 Current appraisal: $140,000
* New loan amount $220,00 so I suppose that means the bank ate roughly $80k
* Interest rate on new loan has been held at 2% for a period of time.

So the new loan is still upside down, with a Loan-To-Value of over 100%, but you can see that the customer can stay in it (albeit maybe just for a while longer).

I don't need one... but hey, where's my bailout? :)
Nelson
Friday, October 10, 2008 3:28:31 PM (GMT Daylight Time, UTC+01:00)
The alternative, of course, is that massive general inflation raises prices and wages to the point where they've caught up with house inflation.
Curt Hagenlocher
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