When housing prices decline sharply, it can create a significant problem for people with home mortgages. Many people may find themselves owing more money than their home is currently worth. This is called an upside down mortgage.
There are other types of loans that go upside down almost immediately. If a person finances a new car and doesn't have a sizable down payment, the car loan may quickly be valued at more than the car is worth. Generally, the terms of car loans don’t last for more than five years, and most people don’t intend to sell cars right away. It isn’t common to try to sell a car when you’re still in the midst of paying for it. You’ll probably owe the loan company money if you do.
The upside down mortgage on a home can create very significant problems and has done so especially with subprime and interest only mortgages. Since insurance payments are higher with subprime loans, payments to principal are much smaller. Interest only loans are even worse because no money is paid toward the principal. This means if housing value goes down, you have little if any money paid toward the principal. A small decrease in home values could create an upside down mortgage.
When economic times are hard and job loss prevails, people may need to sell their homes because they cannot afford mortgage payments or they face home foreclosure. The bank usually takes financial loss when foreclosure occurs, but this action also damages the former homeowner’s credit. When foreclosure or sale occurs, the previous owner walks away with nothing and any investments or former equity in the home have been lost to declining home values.
It can be of serious concern when people have an upside down mortgage. Unless a borrower is willing for a bank to foreclose, the home usually can't be sold without serious damage to their credit. Remortgaging the home isn’t an option either, because most lenders can only loan money up to the current worth of the home. If the borrower suddenly can’t meet the payments, the situation is grave.
There is some movement in various governments in the world to create more systems for people in this situation who cannot afford payments. Especially since the subprime mortgage crisis in the US, the US government has explored numerous ideas on how to restructure upside down mortgages, allowing homeowners to keep their homes and banks to take fewer losses. Economists advise that if borrowers can stay in an upside down mortgage, eventually it can be of benefit. When housing prices rise, the money owed on a home could be significantly less than market value of the house, which translates to profit later on.