Thursday, August 30, 2007

Why People Could Walk Away from their Homes even when Employed

I suddenly had a brilliant idea. Bulls on housing say that as long as people have jobs, they will keep paying their mortgages. But suppose the price of my own falls by, say 10%. Then, it might be better for me to walk away from the mortgage on that home, and buy the same home at 10% lesser price. My decision will depend on how much equity I have built into my previous home, as there will be penalties associated with walking away from my old mortgage. Plus, because of my now suspect credit history, my new mortgage might be at a higher interest rate. But, at a certain level of decline in the price of my old home, that could be a worthwhile tradeoff. So the rate of home price decline could be a more important variable than the rate of employment.

There is an entire category of people in the US who have very little equity in their homes today - they took option ARMs in the last 2 years. Why shouldn't they let their house go into foreclosure - whether they are prime or subprime, and whether are employed or not - when the ARMs reset in the next year or so?

In 1988 in Japan, people used to take 3-generation mortgages to pay off the loan on their house. Thereafter, real estate prices collapsed by 50% (or 30% or 80%, need to check on this). Why didn't people just walk away from their loans? Maybe they did. And banks became insolvent because of the NPAs. But because of the guarantee of the Japanese government, there were no failed banks. That is what maybe commentrators mean that Japanese just prolonged their agony by supporting their banks.

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