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Friday, March 12, 2010

Paying an Underwater Mortgage

I saw an article that contained a big error. Suppose you "own" a house with a mortgage. (Via property taxes, nobody in the USA actually fully owns their house.) Due to the declining housing market, your mortgage is worth more than the value of your house.

Suppose you have a job, and can still afford your mortgage payment. Should you abandon your house?

The correct answer is "not necessarily". It's a difficult calculation. True inflation is much greater than interest rates. The interest on your mortgage may be 6%, but true inflation is 20%-30% or more.

Let's use a specific example. Suppose your mortgage is for $500k and your house could be sold for $400k right now. You have equity of -20%. You owe $100k.

Suppose your mortgage has 6% interest, but housing prices will rise by 16%, a reasonable assumption if true inflation is 20%-30%. Assume that you can afford your mortgage payment. After 3 years, you'll have positive equity again. Inflation bailed you out.

This is the same trick that the banksters use. Due to the recession/depression, most/all large banks were technically insolvent. If forced to liquidate at current market prices, they would have been unable to pay off their creditors/depositors.

Via "level 3 accounting", banks were able to keep operating as long as they could meet interest payments. Bailout money from the Federal Reserve and the Federal government eased this process. The banksters borrowed at 0.25% while inflation is 20%-30%+.

The banksters were bailed out by inflation. If you keep making payments on an underwater mortgage, you're using this trick, albeit on a smaller scale. You don't have as high leverage as a bankster, but it works in your favor.

If you own a house with an underwater mortgage, there's an implied call option. If the price of the house rises, you profit from leverage. If the price of the house tanks further, then you default.

If the value of the implied call option is worth more than the cost of the mortgage payments, then you should keep paying your mortgage (if you have the cash or a job). It's an even better deal if you consider the transaction costs associated with buying a house and the cost of renting another place to live.

One negative factor is property taxes. Under normal circumstances, that's only 1%-2% of the value of the house. However, in some cities there were a lot of property tax defaults, combined with a crashing housing market. This led to higher property taxes for everyone else.

State parasites demand the same amount of tax booty, even while the slaves are suffering a recession. Under such circumstances, the property taxes owed are more than the value of the house. This makes the value of the house $0. In effect, the State has stolen your house via property taxes.

Property taxes are a huge drag on property "ownership". There are reasons to not default on your mortgage, besides the implied call option.

  • You might not be able to get another mortgage/house if you default.
  • You trash your credit rating if you default.
  • You still have to live somewhere. If you abandon your house, you'll have to pay rent.
  • It's your home and you don't want to move.
  • There are costs associated with moving.
  • Even if you could buy another home, you would have to pay another real estate agent's commission, another set of closing costs, another set of mortgage financing fees, etc. There's a lot of fees when you buy a house.
Summarizing, it might be in your rational self-interest to keep paying an underwater mortgage, if you're employed and can afford it. There's an implied call option, because the price of your home will probably rise faster than the interest rate on the mortgage.

If you do own a home, you shouldn't keep refinancing every time housing prices rise. "Always maximize your leverage!" only works for the banksters, who are "too big to fail" and always get a bailout. If you're too greedy and you're a non-insider, then you'll lose everything during the next recession/depression. You never know how long the recession will last and how severe it will be. As a non-insider, it's too risky to max out your leverage. Use leverage when buying your home, but keep it mortgage-free once it's paid off.

If you own a house with an underwater mortgage, it isn't necessarily in your rational self-interest to default. This assumes you have a job or can otherwise pay your mortgage. The interest rate on the loan is less than expected inflation, which makes it potentially profitable to keep paying your mortgage even if it's more than the current market value of your house. It's a tricky and complicated calculation.


Scott said...

Underwater mortgages are a huge drag on property taxes since their inflated values screw up appraisals for those of us who didn't buy into get rich schemes.

The banks are insolvent anyway, and they have proven they are not allowed to lose money on bad mortgages no matter what.

I would like to see all underwater mortgages abandoned so the banks can sell them at their true value, which is in some cases 1/10 their appraised value. A home in my neighborhood that had sold for $560,000 two years ago was auctioned off by the bank last month for $72,000. This needs to keep happening because my tax appraisal value is substantially more than my house's market value, and that pisses me off.

Scream said...

Last year the was very little inflation. In fact there was no COLA for peeps on Social Security. What make you think that we are about to go into hyperinflation?

Scott said...

We are about to go into hyperinflation because they are hyperinflating the money supply and inflation of the money supply is what inflation is.

You can have other factors holding back the inevitable temporarily, but not for long. Exponential growth will kick your ass in the end.

Right now the dollar is tied to oil prices, so the dollar inflation loss is being spread globally. Right now, other countries that depend on oil are negotiating to break the US dollar-oil stranglehold. Once that happens, the US dollar will be in free fall as its true value is assessed.

The government claims that there is zero inflation are fabricated. I keep careful track of my costs. My energy, food and gas costs have gone up over 100% in the last 3 years. Not 5%.

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