Underwater Mortgages occur when the market value of the home is less then the amount of the home loan.
In the united states the housing market peaked in the early part of 2005. By 2006 the market started declining and continues to decline and may not have yet hit bottom. Typically when a buyer purchases a home they put up a portion of the cost of the home and the bank finances the rest. Traditionally the buy would put up twenty percent cash and finance eighty percent through a loan from the bank. As real estate climbed in the early part of this decade buyers were putting up less equity and borrowed increasing amounts from the bank to purchase their home. When the market turned the owners quickly lost their equity. In many cases the home owner lost all their cash they put up to buy the home only to be left with a loan that was higher than the market price of the home.
These loans are defined as a home owner having a loan on the home that exceeds the current market value of the home. This depicts the home owner drowning in debt. For some home owners this is not a serious problem. A home owner may be in a financially sound condition with a secure job and have no intention of selling the home. When the purchased the home they had a long range plan and are simply waiting for better times. However, many home owners found them selves in a difficult situation. Some home owners purchased their home with a variable mortgage rate. When their mortgage rates adjusted and increased their mortgage payments they found themselves in a position where they could no longer afford making their mortgage payments. The housing bust played a significant role in the down turn in the economy. Many home owners found themselves without a job due to economy downturn. Or, found their incomes reduced. These home owners found themselves in a situation were they could not afford to make their mortgage payments. This is a very difficult situation to be in especially when these homeowners have a negative loan. As a result foreclosure rates started increasing in 2006 and continued to rise in 2007.
How big of a problem are these loans?
It is estimated that over a million home owners have negative loans. There are so many foreclosures that banks are having a hard time keeping up with processing all the inventory of foreclosed homes. The banks are looking for alternatives to foreclosing on the home. In many cases the banks are working on deals with the home owners that creates a mutually beneficial situation. The deal allows the homeowner to stay in their home. The bank wins by avoiding taking on another foreclosure problem.
In the past banks required home owners to cover twenty percent of the cost of the home at the time the home was purchased. The bank would only cover up to eighty percent. Perhaps there is sound reasoning for this practice. It would install a buffer if the housing market turns downward. This buffer would help in keeping banks solvent. As we have just seen it is difficult for the banks to manage themselves. If banks can not manage them selves then regulations may have to be put in place.