There are two main ways that mortgages end up underwater: Decrease in property value or missed payments. Let’s take a closer look at how this can happen. Decrease In Property Value Say you plan to buy a home for around $200,000. The bank orders an appraisal and the appraiser determines the home is worth $200,000. Satisfied, the bank gives you a loan for $160,000 because you put down $40,000 as a down payment. A couple years later, you notice that your neighbors are having trouble selling their homes. While the average property value in your area was $200,000 when you bought the home, homeowners in the area have lowered their selling prices to meet the lack of demand.
Now, thanks to a decrease in property values, your home is only worth $120,000 and you still owe $155,000 on your mortgage.
Missed Payments
Your mortgage can also go underwater when you miss your mortgage payments. Let’s look at how that might happen.
When you start making payments on your loan, most of the money you pay goes toward interest. As you begin to chip away at your principal loan balance, you pay less and less in interest. This process is called amortization.
If you fail to pay off your interest one month, that interest will accumulate. Compounding interest makes it difficult to pay back your loan and may also put you underwater.
Let’s say you borrow $130,000 to buy a home at 4% APR with a 30-year term. On your first payment due date, you owe $620.64. A total of $187.31 goes toward reducing your principal balance and the remaining $433.33 pays off the interest your loan accumulated since you took it out.
Missing your payment means that the additional amount will also accumulate interest at 4% APR. You’ll go further underwater if you don’t make a payment equal to two monthly payments the very next month.
This is why it’s so important to make sure you don’t buy a home you can’t afford.
Understanding the complexities of mortgages and their potential pitfalls is crucial for homeowners. The article delves into two primary reasons why mortgages might become underwater: property value decrease and missed payments. Let's break down these concepts with a touch of expertise.
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Property Value Decrease: When property values decline, homeowners can find themselves owing more on their mortgage than the property's current value. This shift occurs due to various market factors affecting the neighborhood. I've seen instances where individuals initially purchase a property at a certain value, only to witness a downturn in the market, diminishing the property's worth significantly. In the scenario outlined, the property's value plummeted from the purchased $200,000 to a mere $120,000, leaving the homeowner with a mortgage of $155,000, which exceeds the property's present value.
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Missed Payments: Another way mortgages end up underwater is through missed payments. The article explains how interest accrual plays a pivotal role in this situation. As mortgage payments primarily service the interest initially, any missed payments lead to compounded interest accumulation. This compounds the problem, making it challenging to catch up on payments and eventually placing the homeowner in a position where they owe more than the property's actual worth.
Moreover, the article highlights the process of amortization, wherein initial payments primarily cover the interest. If a homeowner misses a payment, the interest not paid continues to accumulate at the stipulated APR, amplifying the financial burden.
It emphasizes the importance of financial prudence when purchasing a home, emphasizing the need to ensure affordability. Buying a property that stretches one's financial limits could potentially lead to defaulting on payments, especially if unforeseen circ*mstances arise.
In essence, the article elucidates how property value fluctuations and missed payments interplay to potentially place homeowners in precarious financial situations. Understanding these factors is vital for individuals navigating the realm of mortgages, enabling them to make informed decisions and avoid the perils of an underwater mortgage.
