Dear Dr. Don,
I purchased a house 10 years ago and financed it with a 30-year fixed-rate mortgage for $220,000. The outstanding loan balance is $200,000. If the current value of my house is $160,000, does that mean I have absolutely no equity in my house? I am curious if my better option would be to walk away from the property (mortgage default) and start over with a new house and a new mortgage.
-- Justin Jericho
Your equity position stated simply is what you own minus what you owe. You own a house worth about $160,000. Subtracting out the $200,000 loan balance gives you a negative equity position of $40,000. You have no equity in your house.
There's been a lot of discussion about "strategic default," where the homeowner walks away from the house and lets the lender take the hit based on declining real estate prices. Holden Lewis wrote about it in a blog column last month titled "Default and Rent."
There's a reason it's titled default and rent. You're not going to be able to start over with a new house and a new mortgage any time soon. The foreclosure on your current mortgage means you'll spend a few years in the penalty box before another lender will be willing to loan you money on a home. It probably won't take the full seven years that the foreclosure stays on your credit report to get out of the penalty box, but you won't be getting a new home loan in the near future.
If you can afford the payments, sticking it out and waiting for real estate values to recover isn't a terrible strategy. I'll admit to being a little old school on this topic. You bought the house. You should be taking the downside risk on the housing prices. You weren't going to share any upside profits with the lender, so why should the lender shoulder your downside risk?
You can make a decent counterargument that mortgage investors, by getting the government to bail them out, didn't have to accept their downside risk when the bottom fell out of the mortgage market.
You can also argue that housing prices wouldn't have fallen so far if these same investors didn't extend credit to people who shouldn't have received it, causing house prices to be bid up to unsustainable levels. Forces beyond your control created this mess. You're going to pay for the bailouts with higher taxes; do you have to pay for it twice by staying in your mortgage?
In the end, for me, the answer is that walking away from a mortgage is a last resort, not a financial strategy to maximize my net worth.
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