A ton of things. For some reason, a lot of journalists write about these problems being the fault of the banks loaning money. Well, it is clear that the banks were overly aggressive in setting lending terms. That is, they were willing to give credit to people who were simply not worthy of the amount of credit being offered. It wasn’t just out of the goodness of their hearts, either.
In your case, with the $500,000 home featuring walk-in closets and the mini-water slide into the back yard pool, maybe a home for $300,000 would have been a better financial fit. In that case, you could have still put $50,000 down. Your mortgage would have been $250,000 at 6%, or less (smaller mortgages generally carry lower interest rates because they are easier to pay back, more liquid – i.e. more buyers of small homes than large ones, and because the government helps small home buyers buy, injecting cash into the mortgage system for small mortgages so interest rates are lower).
In this case, maybe your rates were more like 5% on the $250,000 so your interest was just $12,500 a year with your payments being a third less or so than the $500,000 home. Sure, your $300,000 home would have gone down in value – but smaller homes tend to go down less in value because there are just so many more buyers for them, even in bad times.
So let’s say it went down 15% and carried a market value of $300,000 - $45,000 = $255,000. There are still the 5 grand in closing costs and the commissions (which are less on a home with a smaller purchase) – 5% of $255,000 is about 13 grand. So subtract another $18,000 from the $255,000 closing price you got when you sold this one and you net in your pocket $237,000 ($255,000 - $18,000).
You owe the bank. You have to pay back the loans you took. But you spent 4 years in this $300,000 home and, since it was so much cheaper to manage, you were able to save a few bucks more (that $20,000 in lifetime savings is now $30,000) and you paid down your loan from $250,000 to $240,000. So you owe the bank $240,000.
You just got a check from the buyers for $237,000. So you are $3,000 under water on the house. But given that you have $30,000 in savings, paying off $3,000 and just “starting over” is not the end of the world. Unlike our first example, in which case you might be better off if your house really is under water.
You’ll have lost the $50,000 you made as a down payment on the home, but you get this amount as a tax credit. That is, as you have gains on future investments, you don’t have to pay taxes on them until you have made over $50,000 in profits. So it’s a painful lesson but… you’ll have survived.
Yeah, you lived in a home without walk-in closets and a water slide. But you lived to fight again. And, if you’re fortunate, to one day slide again.
Was it the bank’s fault for loaning the $450,000?
Or was it your fault for taking on more than you could afford?
And what really could you afford?
OK, sermon over. Here’s the gritty and the nitty on mortgages, the math, the R-rated version. Before reading, please make sure all small children have left the room.