how does a falling economy cause people to default on their house mortgages, if their loan amount and income stay the same?

Question

how does a falling economy cause people to default on their house mortgages, if their loan amount and income stay the same?

In: Economics

Answer 1

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.