Why is my House Losing Value?

Many homeowners are stuck with houses that are virtually impossible to unload. With their interest-only loans about to convert to conventional payments, some homeowners are facing mortgage payments too big to pay.

They are saddled with homes they purchased before the house-price crash. Most analysts actually see the recession as a result of the housing market crash.

To begin with, the subprime lending industry began utilizing interest-only loans. Subprime loans are typically given to buyers seen as a poor credit risk by banks. This could be due to many factors, not just delinquencies or bankruptcies, as those with little credit history are in this group as well.

In the past, subprime loans typically meant higher monthly payments due to the higher interest rates charged as a result of the buyer being a poor credit risk. Also, the buyer was usually expected to have some form of down payment. A down payment lowers the interest rate and repayments because the banks see a buyer having their own money in a home as a slight insurance against default.

Most high-risk borrowers were not able to afford a big enough down payment to lower the rate or monthly payments significantly. So only those who could either afford to put up some of their own money or those who could afford high monthly payments would borrow in the subprime market. The advent of the interest-only loan changed that.

Subprime lending, in and of itself, is not a bad thing. But when high-risk borrowers get loans for houses they technically can’t afford, it turns into a powder keg waiting for a match. The interest-only loans that allowed these borrowers to buy houses at inflated prices turned into conventional loans with much higher payments that their owners could not make.

The anatomy of an interest-only loan is something like this:

• There is usually little or no down payment, which means the buyer has little of their own money invested in the loan and is more likely to default when things go south.
• The monthly payments are initially low as they are only for the interest on the loan. This time period of interest-only payments can last for one to five years.
• Once that time period is up, the loan converts to a conventional loan, with higher rates depending on if the loan is attached to the U.S. treasuries or the London Interbank Offered Rate (LIBOR, the rate at which banks lend to each other). If it is based on U.S. treasury rates, then the payments are lower than if based on the LIBOR.

With the way the housing market seemed to be going up and up and up, many buyers believed that they could sell their homes at a higher price before the interest-only term of the loan ended. Unfortunately, the housing market crashed and with it house prices.

How did the housing market crash bring about the recession? It can be broken down as follows:

• Subprime, interest-only loans are given to poor credit risks with little to no down payment, opening the door for future defaults.
• Banks bundled these loans into packages known as mortgage-backed securities and sold them globally.
• When defaults piled up and foreclosures began to abound, investors who purchased mortgage-backed securities lost money.
• These investors stopped purchasing this type of securities, so banks were now on the hook for the bad loans.
• Banks knew that other banks were also carrying the dead weight of bad loans; consequently, they would not lend to each other.
• Credit markets froze as lending ceased and recession hit.

Since homeowners couldn’t afford their payments and subsequently defaulted, banks and investors lost money. Those same banks and investors stopped putting money into the credit markets, and people had trouble refinancing, purchasing new homes and getting regular credit.

This, in turn, led to lowered consumer spending. As consumers weren’t spending, many businesses lost money. When businesses lost money, they didn’t borrow money to expand their business. No expansion and lack of money led to layoffs and cutbacks on hours and production, which led to more defaults and less spending.

Once the economy began to slide and jobs were lost and businesses went bust, many began to lose faith in the market. More investors were holding onto their money and the recession worsened.

As the economic downturn became more pronounced, house prices fell further. Few people could borrow the necessary funds to purchase homes as lending dried up. With more sellers than buyers, many homes are being sold at “fire-house sale” prices.

Also, many people were worried about losing their jobs due to problems their employers were facing. This, of course, meant that spending decreased further.

It is a vicious cycle that occasionally begs the “chicken or the egg” question. Which came first: the house-price crash or the recession? In this case, the crash of the housing market led to the initial economic downturn. But the recession may further push down the price of homes.