ProfessionalHFAnalyst

The Housing Bill: Uncle Sam Is Moving Into the Spare Bedroom

The illustration above with the $500k hoome in which a buyer put down $100k in cash is not the kind of homebuyer that is in trouble right now, for the most part. Most if not all of the homes in trouble had close to zero equity in them back when thee mortgages were issued. That is precisely why so many people are sending the key to the bank, since they have invested zero of their own money in the home to date.
A more realistic example of the $500k home.
(1) Home is purchased in 2006 for $500k, with $400k in mortgage and $80k in second mortgage, to avoid having to pay PMI (Standard trick that everyone did). Equity stake is therefore $20k.
(2) Home prices tick down 4% in 2007. Equity is already wiped out, but homeowner stay in house, figuring that market will turn around shortly and they will be able to sell at a profit as originally anticipates.
(3) Home prices fall hard in 2008, say 20%. Home now worth $384k. Prospects for recovery look bad. So homeowner sends keys to bank and walks away. Net: got to live in a nice house for 3 years at a cost of $20k of equity capital.
(4) Wait, govt steps in. Forces lenders to write off loand above 90% loan-to-value. Since home is worth $384k, 90% of that is $345k. Second mortgage issuer gets wiped out 100%, losing $80k. That should have been written off by now anyway. First mortgage holder therefore takes hit from original $400k loan to $345k, i.e. $54k. Government now issues loan to you for $345k, 30 yr fixed rate. Not clear so far if the govt pays some of that $54k loss to the mortgage originator to entice them into doing this deal. But net-net, you got a big bonus for overleveraging yourself and living beyond your means.