Peter Boockvar, chief investment officer at Bleakley Advisory Group, says he feels bad for people who have bought a home in the past year. Appearing on CNBC News, Boockvar in no way suggested that the economy was about to plunge. On the contrary, the investment expert spoke with compassion about those who stand to be most affected when and if house prices correct.
According to Boockvar, it is those who can least afford the financial blow who are likely to suffer the losses. Let’s say a buyer hoping to take advantage of historically low interest rates entered the market late last year. With the nationwide increase in house prices hovering around 15%, imagine this homebuyer got lucky and bought in a city where prices only increased 10%. So, putting a 5% down payment on the house, the buyer moved into a property worth 10% more than the previous year. So far, so good.
Here’s where things get sticky. If house prices correct and the value of the buyer’s property suddenly returns to its pre-pandemic level, it is immediately worth 10% less than what he paid. The buyer has only put in 5% of funds, and the same goes for “underwater” – they owe more on the house than it is worth.
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Disadvantages of being underwater
Once an owner owes more on a property than it is worth, there can be several issues, including the following.
Inability to refinance
Lenders will not allow a homeowner with no equity in a property to refinance. They fear that a homeowner may not have the “skin in the game” and be more likely to give up their mortgage. Plus, no lender wants to lend more on a home than it’s worth.
No access to home equity
A homeowner with equity in a home knows that it is possible to borrow money on the property to cover the cost of an emergency, pay off high interest debt, or make improvements. Without home equity, those options disappear.
To find out how expensive being underwater can be, imagine that a homeowner owes 5% more than the property’s value, but has to sell due to illness or job transfer. It might look like this:
- The owner owes $ 200,000 on the mortgage.
- Since home values fell, the home is now worth around $ 190,000.
- The owner asks for $ 195,000 for the property, but gets no lessee. The ultimate sale price is $ 190,000.
- Between real estate agent fees and closing costs, it takes $ 17,100 to sell (9%).
- The homeowner must also bring $ 10,000 to the closing table to make up the difference between the amount he gets for the house and the amount he still owes, plus realtor fees and closing costs. So it takes a total of $ 27,100 to get out of the mortgage.
Being underwater on a mortgage can be devastating for a homeowner who can’t easily find the cash to bring to the closing table.
Stay the course if possible
There is a strong connection between an underwater mortgage and foreclosure – and it may be natural. It’s hard to pay for a house more than it’s worth. But like most financial matters, it’s all about making the best long-term financial decision.
Over the long term, the homeowner can potentially increase the equity in the home, speeding up the process by paying an additional amount for mortgage principal each month or making an additional mortgage payment per year. History shows that house values are likely to rebuild steadily over time. Rather than suffer from the idea that they are paying too much today, a homeowner can profit by looking further ahead and imagining how interesting the equity in the building will be. And while they get there, they can still deduct some of the mortgage interest on their taxes.
Even if a landlord needs a roommate to help them cover their mortgage, it almost always makes more sense to keep promises made to the mortgage lender than to get out sooner. Time is the great healer when it comes to rebuilding equity, and remembering that the situation has a long-term solution can prevent a homeowner from leaving their home and taking out a mortgage.
Giving up a mortgage can disrupt a person’s financial life for years to come. For example, if moving away results in foreclosure (which almost certainly will), the owner’s credit rating may drop by 100 points or more. Suddenly, a person who had a credit score of 740 is dealing with a score of 640 or less. This makes it harder to qualify for other types of credit – including credit cards, personal loans, and auto loans – and makes it more expensive to obtain a loan. A foreclosure also stays on credit reports for seven years, and this can impact everything from getting a workplace safety clearance to renting an apartment.
If a financial situation becomes more complicated than expected, that doesn’t mean it’s impossible. Would it be disappointing for a new owner to end up with less equity than he hoped for? Absoutely. But they still own a home and can still work on building equity that will help them feel financially secure.