WSJ: Confessions of an Underwater Homeowner

Remember those poor bastards with 18% mortgages in the early 80'? Sorta feels the same.

Ah, but people with 18% mortgages could refi when rates dropped. These poor folks are stuck with the price they paid. However, I do think this is a really good example of how people making decisions within the context of what makes sense for their lives at a given moment are getting clobbered by this entire mess. Also a good example of how people have been so stretched by home prices.

prices were so low in the early 80s that those who bought are up +300% on their investments. and/or they have since refinanced or paid off their mortgages completely.

One thing that I took from this article is that either the homeowner or his/her attorney should carefully read the loan paperwork and understand exactly what are the terms/conditions of the loan(s). For someone who works for the WSJ, the author didn't seem to completely understand what the loan was really about. I know that it's tedious and complicated language, but it seems necessary to understand what type of loan you are getting.

Lobster, agreed, but my takeaway here was rather different: if even a highly educated individual familiar with the finance world got blindsided by this, how reasonable is it to expect that less highly-educated or otherwise sophisticated people would see through it? Before signing, he *did* understand the terms of the loan. They signed knowing there was a balloon payment. The projections did not account for a downturn in price, so it seemed reasonable. If you're not really what a balloon payment is or how that's supposed to amortize over time, people are breathing down your neck to sign some papers, and those papers are all that's standing between you and your dream home, I can understand how that might have seemed like an acceptable risk to take. Not that this is what happened in the story; I'm just contextualizing a bit.

The article said something about how at the time of closing, he didn't know that the second loan was a de facto home equity line of credit. I realize that his attorney told him about the balloon payment in 14/15 years. What puzzled me is why the author only found out about this stuff at the closing. Shouldn't someone at the bank have discussed this in greater detail? Of course, at the closing with everyone passing around papers to sign, you can't sit for two hours and read a loan document.

I think the following is the most important point from the article:
"Apparently, if my home doesn't rise 1.94% in value over the next seven years, we should call it quits.
We wouldn't. Although, if I were laid off and unemployed for more than a few months we might have to."

evnyc and sunday, I realize that what I'm talking about is not the focus of this article. I just found it strange that the author didn't fully understand what type of loan he was taking out and only found out about the balloon payment at the last minute. With a balloon payment, I would think there is always a danger that the homeowner won't have the money to make the payment independent of whether or not the house goes down in value. But I'm looking at this article as someone who will soon go through the mortgage process so that is my focus.

lobster, I am no longer surprised by such things.
I was stunned by how many people think that if they were making $67,900, it's better to turn down a $5,000 raise from their boss because they would go move from the 15% tax bracket to the 25% tax bracket! My non scientific sampling included accountants (though not tax accountants), people with MBA's, etc...

The lines I pointed to from the article adds to my believe that foreclosures due to loans being underwater will increase as people stay unemployed for an extended amount of time. Since unemployment will remain high for at least a couple of years, foreclosure rate will likely increase causing prices to drop even more, dragging more loans underwater...

Look at it from this point of view: regardless of whether it was financially wise to buy with their debt-income ratio - what would happen if the writer lost his job? Stopping payment on mtge and going slowly towards foreclosure might mean that they remain in their house (with all its comforts) longer than if they rented (though they would have more in savings).

I think that a net effect of all these foreclosures will be a real test of extended family networks. When all else fails, you can move in with your boomer parents... Not so different from the Great Depression when you had large extended families sharing a two room flat.

Lobster, I've never closed myself (renter) but I understand from people on this board and listening to friends and family who have purchased that there is always something at the closing. I think banks should be required to disclose in ordinary language the terms of any loan they are making. There should be major fines if they do try to obscure the costs and terms of the loan. And it seems likely to me that the terms of the 2nd loan probably were exposed, but that they were not explained in a way the buyer could understand until the lawyer pulled him aside at closing.

I think the good news is that 1.94% is a pretty low bar. It's possible that could happen in 7 years time, not an outrageous hope. Even if housing prices fall another 10 or 15% in the NYC area over the next couple of years, which I think they probably will, it's possible that prices will appreciate enough to pull off that 1.94% rise.

They have triplets, so wife could conceivably go back to work and net some $ as their childcare costs are reduced.

Fortunately for the author, he is able to make his mortgage payments at this time so they are in no immediate danger of losing their home. It would certainly be a major consideration if he were offered a job in another city that they wouldn't be able to sell their home for what they paid for it. I'm not certain what effect all of these underwater mortgages has on the RE market in a more general way- will banks be even more hesistant to make loans to buyers because of increased foreclosure rates? This article seems to demonstrate that even the most financially astute buyer can't always time the market (as I sit and look at my Citigroup stock which I purchased at much higher than $3/share).

nyc10023, how is the little one doing (and you as well)?

"This article seems to demonstrate that even the most financially astute buyer can't always time the market (as I sit and look at my Citigroup stock which I purchased at much higher than $3/share)."

Of course the most financially astute buyer can't always be perfect, but I fail to see how this article demonstrates it. A financially astute person's acumen can be measured from a lifetime of making astute decisions and taking calculated risks in the hopes that your good decision-making, when multiplied over decades, outperforms despite all the noise which no doubt dominates any reasoning you might have.

At the end of the day, all you have here some writer who bought housing at the peak when all fundamental indicators said it was a stupid thing to do, and the issues were well-publicized. That does not sound like good decision-making. Hell, if you want to point to an article that "demonstrates" what you are talking about, find one about Buffett self-bemoaning his energy investment last year or the fact that he didn't perfectly time the bottom in March of this year. But some random WSJ writer?

You're obviously one of the people who post here who are either working in finance in some capacity or are very well versed in financial matters. Market timing is a concept that consistently eludes me. Perhaps you can explain what effect these underwater mortgages has on the RE market in general for those of us who don't have an economics or finance background.

I'm not sure what "market timing" really means. The key thing to keep in mind is that while markets are for the most part "efficient", they are by no means "rational". In an efficient market, you cannot predict future prices: everything is already accounted for in the existing price, and only new unknown information affects price. In a rational market, prices reflect underlying fundamental values. We pretty clearly have efficient markets. Oodles of money managers bust their humps professionally year-after-year and have a hard time beating the market, and the ones that do so consistently are the first to admit that markets are very efficient in the sense that the edge you can have over the market is miniscule. On the other hand, markets can be quite irrational as demonstrated by our recent bubbles and bubbles going back centuries. It has been shown that "noise traders" (i.e., ones who do not look at fundamentals) can drown out, outperform, overwhelm, and spank "rational traders" (i.e., ones who do look at fundamentals and trade to push prices back to rationality), hence leading to the possibility of having an efficient market (one that unpredictable) while being irrational (not tied to fundamentals).

So what does this all mean for you? A small amount of edge can be had by being "rational" in an irrational but efficient market. It won't lead to consistent profits, and you have to have very long time horizons, but it's one thing that most "regular" persons can actually practice. One of the most storied investors of our time (Buffett) built his career on such this idea: he has done things like sit out the stock market for a decade waiting for prices to become "rational". Is that "market timing"? Sure sounds like it to me. Can you practice it? I'm pretty sure you can. Just do what Buffett does, or if that's too hard, just copy whatever he does. The key thing is to have patience, have a strong stomach to take losses and add to your position when you are being spanked, and be willing to sit out a bubble even if you're the only silly one to be doing it. Do that for a few decades, and after all that time you might have a track record that shows some level of consistency.

"Perhaps you can explain what effect these underwater mortgages has on the RE market"

Hard to say, if you ask me. Changes in prices do certainly predict changes in the number of underwater mortgages, but I'm not sure if the reverse could be stated. I.e., you could have a market with lots of underwater mortgages (caused by severely depressed prices), but prices have been so depressed that fundamentals point to prices going up. Or, prices could still be too high and fundamentals point to prices going down. Does this mean that prices will go down? Hardly. Government regulation might change things. There might be an echo bubble because people still think RE is a place for levering up and making big money. A bout of unexpected inflation may kick in. No one can say, really.

You can, however, figure out the fundamental price of RE and try to make a rational decision. If you bought in 2006 as our esteemed WSJ writer did, I doubt this was what you were looking at.

I appreciate your detailed explanation. I find it very interesting and informative to hear from individuals such as yourself who can clearly view and understand RE from a financial and not an emotional perspective. I'm trying to teach myself to view buying an apartment as mainly a financial transaction and explanations such as yours help me (and hopefully other buyers).

Here is why efficient theory does not work.

My girlfriend at the time (wife now), used to drive to nj (or made me drive her) to save the sales tax on clothing. It wasn't like she was buying $2K prada shoes... just your ho hum gap sweaters etc etc.. .$300 tops.... so my time, gas, toll, etc etc from 67th street was like $200... .yeh BUT I SHE GOT TO SAVE $16 on sales tax!!!!!!!!!

The female voice as it yells at her significant other somehow warps the "efficient" mkt theory.. it is a vortex from which no sane man, even with a finance phd from Wharton can graph and solve for X.

Glad to help in some small way, my crustaceous red friend. Take everything any of us knuckleheads on this site say with a grain of salt, and remember that no one can really predict anything market-related all that well.

"I'm trying to teach myself to view buying an apartment as mainly a financial transaction"

While understanding RE from a financial perspective is very good, I'll state the obvious: that is not the only perspective that matters. Realize that for many of us eggheads, the financial aspect IS the emotional aspect. Although having a "home I can call my own" matters little to me emotionally, taking a loss or making a profit on a right-sized home for me doesn't make a huge difference financially either. However, making a poor decision financially, regardless of outcome, would be emotionally DEVASTATING to me.

See, it does all come down to emotions ;).

Didn't hit refresh before posting, w67th. True dat, dog, on the female voice. However, I don't think that's a counter-example of the efficient markets, just one against rational markets. Luckily for me, my wife is abnormally rational: no nesting impulse whatsoever. Always saying "why the hell do people feel they must own their home so much"? The only motivation from her for ever uttering the words "maybe we should buy" was from the financial side, about which she did her own analysis and shot down quickly.

This guy made the same mistake countless others did during the boom period. Why were they prepared to buy when they had not been able to save enough to put 20% down? That would have eliminated the whole need to take on the high interest rate "balloon" loan. Isn't it obvious that the possibility of becoming "underwater" increases when you have so little equity right out of the box? In general, someone who is incapable of coming up with 20% (which demonstrates at least some ability to defer consumption and save) is at high risk of subsequently defaulting on the mortgage (unless bailed out by rising real estate pricing that enable a refinance). How this guy was able to sleep at night knowing the huge risk he had taken on is beyond me. He also works in media which has zero job security right now. Unbelievable.

Re: the balloon mtg, what this article shows me is the dumbing down of the USA. Even if he didn't know/understand about the balloon, why did it never occur to him, prior closing, to think about how/when the mtg would be paid off? This is basic common sense, which very few seem to possess.

I agree patk14. We've become a nation of idiots.

agree, w67: buy yer pradas in nj.

"Brian R. Fitzgerald is an editor at WSJ.com. "

Dude's an editor at WSJ???? Acch.

Dwell, read the article. He didn't know about the balloon prior to closing, and rather than let it derail the deal he signed off on it anyway based on what seemed like reasonable expectations at the time. It's not basic common sense; it's the difference between renting a place that's too small for a suddenly expanding family and then making the best choices possible under the circumstances. As the author states, if he had known there would be a collapse in prices he wouldn't have bought then. Markets are only truly efficient when there is a perfect flow of information. This guy worked for the WSJ and didn't see it coming; remember at the time that many calling the housing bust were regarded as a lunatic fringe.

I have never gone to a "signing" in my life without having been given and read through anything I'm about to sign, no matter how small. This guy is no wiser than an average Joe, if you ask me, and this should give all serious concern about the quality of "advice" coming from journalists.

evnyc: I did read it, but, I still say he's a dumbed down dummy. If I seek to borrow $, one of the first questions I'd ask is "how is the loan repaid?" & I'd ask this qu BEFORE agreeing to take the $. Point is that finding out the mechanics of repayment is a natural, logical thing to ascertain before formally taking the loan. One should know the terms of the deal before taking the deal. IMO, he went into this purchase asleep & blind.

I think this is rather obvious:
"As the author states, if he had known there would be a collapse in prices he wouldn't have bought then"

I understand that many, many people did the same thing that this guy did, but that doesn't make it right, nor smart.

I also blame the banks; they should not have lent him this $ on these terms. I also blame congress for creating legislation that allowed banks to do this. This whole situation is one big klusterf*k.

Dwell: But most people don't even understand compound interest, let alone amortization of a "normal" loan. What good would it do for them to read page to page? Of course, this guy is a WSJ editor, so he should have known better.

I agree that loans should have obvious writing, like the calories on the back of food packaging. It should be simple and easy to read.

Of course, folks are off their rocker if they think it will change consumer behavior. They will continue eating and getting fat, and taking stupid loans because they think RE will double.

This will, however, end the argument if these people were stupid or suckered. I like consumer protections that are informational, if only because they take away the excuse of "well, I didn't know".

If you didn't know, learn. If it was too hard, GET A DECENT LAWYER. If you took the lawyer of the bank or someone else, you're an idiot. You have to be responsible for the laywer you hire.

If you can't afford a decent lawyer... well, then, YOU CAN'T AFFORD A HOUSE.