What does “mortgage is underwater” mean?
It means the amount of principal and interest due is more than the house is now worth on the market. It used to be the other way around. As property values went up and time went on, your mortgage represented a smaller portion of your ownership.
You would have been building up equity (ownership value) on your house by making payments and having the market value going up. If the market value is going down, at some point you might owe more on your mortgage than the property is worth on the market.
The first day the banker gave you your mortgage, the bank owned the house. Lots of people don’t look at it that way. They say, “Yippee, I just bought a house!” The reality is that the bank bought the house by lending you money to pay for it, which you have to pay back.
Interest is the amount of money the home buyer pays the bank for the privilege of getting the money to pay the owner/seller. It is expressed in terms of a percent of the amount of money they are lending you.
Say, they loan you $10,000 (the principal) at 10% interest per year. That means you have to pay $1,000 a year in interest, plus your principal payments. How much you end up paying in total depends on how many years you will be paying the bank.
I don’t know if mortgage loans are still structured this way, but it used to be that at first, the interest was a huge part of the monthly mortgage payment, but gradually decreased as the loan was paid off. Payments stayed the same, but more principal was being paid off each month.
You may know it from the other side of the ledger – when you deposit money in a bank, they pay you for letting them have the money, which the banks, in turn, lend to people who want/need it.
By the way, 10% used to be a normal rate of interest, but today it is less than 4%. That means you would only be paying $400 a year in interest. You know what the real estate agent will tell you?
“Since the monthly payment will be lower, you can afford to buy a house for $10,600!” I can’t tell you how many people have fallen for this line.
Let’s answer the question we began with. I think the authors mentioned in the previous post thought “underwater” meant behind in payments. That is not underwater, it is simply in default, after appropriate legal steps have been taken.
Investment tip: read http://www.doctorhousingbubble.com/ before you buy real estate or feature it in your next book!