how does a falling economy cause people to default on their house mortgages, if their loan amount and income stay the same?
In: Economics
Because everything else has been steadily rising in price, eventually, some things gotta give, and it’s often the mortgage.
Companies won’t operate at a loss for long. When UPS and the video game industries laid off a combined 17000 people a lot of mortgages are going to go unpaid.
As you phrased it … there isn’t. Generally, however,a “falling economy” implies incomes are failing (e.g. due to job losses). Or, possibly, an economy with high inflation might see either/both of: (a) more mortgage holders spending more on other basic necessities and not having sufficient left over for fixed mortgage payments; (b) the Fed raising interest rates, causing monthly payments for mortgages with a variable interest rate to then increase, leading to an increased default rate.
You’re assuming their income is staying the same, which doesn’t always happen in a failing economy. Many people lose their jobs, run out of money, stop paying their mortgages and get foreclosed on
For every default on a mortgage, there’s an individual reason. This isn’t a topic that can be summed up with one answer.
I’ll give you the example of my wife and me, since we fit the parameter of the loan amount and our income staying the same:
We bought our first house in 2006 with plans to start our family, build some equity and eventually move a few states away to be close to family. Then the housing market collapse of ’08 happened. The value of our house dropped to almost half of what we initially mortgaged it for. We both still had our jobs, our mortgage was a fixed-rate, and we bought within our means, but we were stuck in a tiny house that we owed way more on than it was worth, with two kids, and two states away from where we wanted to be.
The only way the bank would allow us to do a short sale (selling for less than current value) was to be in default on the loan, so we stopped paying the mortgage. Within a couple of months we were in default, and we were able to easily sell the house through a realtor who specialized in short sales.
It screwed our credit for a few years, but it was a small price to pay for getting out of that money pit, and we’re so much better off now than we would have been had we stayed there.
I think in simplest terms, a failing economy means incomes don’t stay the same. Jobs are lost and or people take pay cuts.
If one’s income does stay the same through an economic downturn and their mortgage rate is fixed and they are staying put, they won’t default.
Job losses from businesses shrinking. No job, no mortgage payments.
High inflation. Can’t afford the mortgage AND food.
And the insidious one. Interest rates. Some people have mortgages with variable rates, so as interest rises so do their payments. As well, in some places (like where I am), mortgages are amortized (paid off) over 25 or 30 years but the *term* of the agreement is typically five years. So maybe five years ago you got a 2% interest rate and now you need a renewal. And the best rate you can get is 6% now. So your mortgage payments just jumped. Maybe so much you can’t afford it.
The full duration fixed mortgage seems to be a US phenomenon.
In other anglophone countries (I can speak for NZ, UK & Australia) mortgages are only fixable for the first few years.
After that they move up or down with the central banks interest rate.
In Australia in the last 3 years central bank rates have meant that unfixed mortgages have pretty much tripled in that time.
There are people coming off the fixed rates every month and even though they’ve seen it coming for years it’s still going to be incredibly difficult to navigate.
House prices here (generally) are still going up and up so they might have some equity to remortgage with as they exit the fixed period but some will end up defaulting.
Others pull back on spending which is the central bank’s intention in order to reduce inflation but it’s a sledgehammer to crack a nut and some people are going to get hurt.
Let’s say you mortgage a house for $500,000 of debt.
Let’s say the economy goes to shit. People are all losing their jobs, and people have less money. As other people start selling their properties as they can’t afford it the valuation of your property drops in value $100,000.
Now what would happen if you were forced to sell your house at the new valuation? Well because you took on $500,000 worth of debt and the sale will now only cover $400,000 of that, this means that even if you sell your house you will still owe the bank $100,000.
Many people cannot pay off that kind of debt and instead foreclose their mortgage and declare bankruptcy. They do this because they would have more debt than money, and with interest rates on the debt, would realistically never be able to pay it back.
In 2008, not all of the mortgages had fixed payments. There were some which had “payment options” which let you pay less than the full amount in some months and more in others while other had “teaser rates” which meant the payment would be low in years one and two and increase afterwards. A lot of people paid the minimum until the payment automatically went up at which point they could no longer cashflow month to month. Most of these creative mortgage are gone.
In 2008 there were also a bunch of mortgages given to deadbeats because “home prices always go up” so they thought the mortgage would be good.
In most recessions, some percentage of people lose their jobs. Also, some commission based people (car sales, real estate, tipped waiters) do in fact see a fall in income. Those people are much more likely to lose a house.
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