A few years ago, a coworker formed an investment partnership in speculative real estate. He promised investors a 10 percent annual return and was using the capital to invest in Florida real estate, earning 15 to 20 percent overall. As most of the real estate had not even been inhabited or built yet, the investments were pure speculation. I haven’t been in contact with this individual, but I am wondering how this business is doing in this real estate market.
If you have a mortgage on a house you purchased recently, there is a good chance you now owe more on this loan than your house’s market value. These chances are even greater if you bought into the speculative markets in Arizona, Nevada, or Florida like my former coworker.
Owing more on your loan than the house is worth is not the worst financial situation, but it is risky. If you need to sell your house, you would still have to raise more money to pay off the remainder of the loan. If, on the other hand, you are lucky, you can remain in your house long enough to continue paying off the loan and to wait for home prices to return to the average rate of appreciation of about 3 or 4 percent. Eventually you could come out ahead.
If you find yourself in this position and you care not to be, you can make the time work harder for you rather than against you by increasing the payments towards your mortgage. A pure analysis of the numbers might say that it’s better to invest in the stock market rather than pay off your mortgage faster, but that doesn’t account for the risk of staying in a house whose loan is under water, and that risk can be measured differently by different families in different situations.
Robert Kiyosaki popularized the idea that a house is a liability. He is, of course, technically wrong. A house, and anything you own is an asset, while a mortgage, and anything you owe, is a liability, despite any marketing materials that try to redefine the words. But when your mortgage is higher than the market value of your house, you have negative equity, and that asset is not looking so helpful on your balance sheet.
This negative equity is mostly a result of speculative investing. The news that so many homes are under water invites criticism of home owners who bought a larger or more expensive house than they could afford and have now suffered the effect of a downturn in the real estate market or interest-only mortgages than have now adjusted to include principal payments. But that is only a small problem in this market, it is the speculative investing that accounts for the under water loans.
The areas that were identified as the largest contributors to the total number of home loans under water were the locations that saw some of the biggest increases in home prices as investors gobbled up as much property as possible. These investors intend on selling more frequently than a typical home owner, so they are more vulnerable to the market downturns that result in negative equity.
Are you under water with your home loan? Are you doing anything about it now or are you waiting for home prices to return?
Published or updated August 16, 2009.