So we all know housing will dip/drop at some point. What happens to your equity in situations when you put down 5% vs when you put 20% down?
- Buy a 500k house and put 5% down (25k) and the next day housing prices crash and your house is now worth 400k.
- Buy a 500k house and put 20% down (100k) and the next day housing prices crash and your house is now worth 400k.
in the first case you are "underwater", correct? What does that mean exactly and what kind of real life implication does each case have assuming you keep paying your mortgage and have the same rental cashflow coming in?
@Chi Wen this is referred to as a "loss on paper" and it is just an unrealized loss. If you don't sell the asset, you lose nothing. That is why the best strategy is to sell assets when prices are high and hold/buy assets when prices are low. Of course markets don't operate like that. The frenzy that drives prices up means there are more buyers than sellers. The same frenzy drives prices down when there are more sellers than buyers.
If you are not selling, the main negative of being underwater is that you end up undercapitalized. This is a problem if you are seeking loans, because you are seen as owing more than your assets are worth. If you don't have other cash equivalents or assets, that can mane negative net worth. If/when a housing market turns bad, it becomes very difficult to borrow money, even harder if you have low or negative net worth.
If you are forced to sell when you are underwater, you may be forced to short sale the property. That is when you sell a property for less than you owe. In most states you become personally liable for the difference. In a serious enough situation, you may be forced to file bankruptcy to get out from the debt. This is the worst case scenario.
So we all know housing will dip/drop at some point. What happens to your equity in situations when you put down 5% vs when you put 20% down?
- Buy a 500k house and put 5% down (25k) and the next day housing prices crash and your house is now worth 400k.
- Buy a 500k house and put 20% down (100k) and the next day housing prices crash and your house is now worth 400k.
in the first case you are "underwater", correct? What does that mean exactly and what kind of real life implication does each case have assuming you keep paying your mortgage and have the same rental cashflow coming in?
If you keep the property it has no effect.
If you try to sell the property you lose your equity. When you are underwater it means you can't sell it for as much as you owe on it and you have to bring money to closing to cover the deficit. Keep in mind it costs you about 8% to sell. So, if you sell at $300,000 it will cost you about $24,000 between real state agent fees, title, concessions, escrow, etc.
For instance, your house used to be worth $350,000 but now it's worth $300,000.
if your loan is at $280,000 and you sell at $300,000 minus $24,000 in selling costs you net $276,000 - your loan payoff is $280,000 so you have to bring in an additional $4000 to close.
This is a great example of why percentages can lie to you.
In the first example (5% DP):
You would have a negative $75k equity.
In the second example (20% DP):
You would have $0 equity.
This is a great example of why percentages can lie to you.
In the first example (5% DP):
You would have a negative $75k equity.
In the second example (20% DP):
You would have $0 equity.
Hi @Joe Villeneuve! Can you explain further where these numbers came from? New to learning. Tryna understand:)
This is a great example of why percentages can lie to you.
In the first example (5% DP):
You would have a negative $75k equity.
In the second example (20% DP):
You would have $0 equity.
Hi @Joe Villeneuve! Can you explain further where these numbers came from? New to learning. Tryna understand:)
Property #1:
Buy = $500k
DP = $25k
Debt = $475k
Property value drops to $400k...you have a negative $75k equity.
Property #2:
Buy = $500k
DP = $100k
Debt = $400k
Property value drops to $400k...you have a $0 equity.
@Chi Wen this is referred to as a "loss on paper" and it is just an unrealized loss. If you don't sell the asset, you lose nothing. That is why the best strategy is to sell assets when prices are high and hold/buy assets when prices are low. Of course markets don't operate like that. The frenzy that drives prices up means there are more buyers than sellers. The same frenzy drives prices down when there are more sellers than buyers.
If you are not selling, the main negative of being underwater is that you end up undercapitalized. This is a problem if you are seeking loans, because you are seen as owing more than your assets are worth. If you don't have other cash equivalents or assets, that can mane negative net worth. If/when a housing market turns bad, it becomes very difficult to borrow money, even harder if you have low or negative net worth.
If you are forced to sell when you are underwater, you may be forced to short sale the property. That is when you sell a property for less than you owe. In most states you become personally liable for the difference. In a serious enough situation, you may be forced to file bankruptcy to get out from the debt. This is the worst case scenario.
@Chi Wen
It means absolutely nothing, unless you try and sell. If you can keep it rented and it still cash flows, then what the market does is irrelevant.
@Chi Wen this is referred to as a "loss on paper" and it is just an unrealized loss. If you don't sell the asset, you lose nothing. That is why the best strategy is to sell assets when prices are high and hold/buy assets when prices are low. Of course markets don't operate like that. The frenzy that drives prices up means there are more buyers than sellers. The same frenzy drives prices down when there are more sellers than buyers.
If you are not selling, the main negative of being underwater is that you end up undercapitalized. This is a problem if you are seeking loans, because you are seen as owing more than your assets are worth. If you don't have other cash equivalents or assets, that can mane negative net worth. If/when a housing market turns bad, it becomes very difficult to borrow money, even harder if you have low or negative net worth.
If you are forced to sell when you are underwater, you may be forced to short sale the property. That is when you sell a property for less than you owe. In most states you become personally liable for the difference. In a serious enough situation, you may be forced to file bankruptcy to get out from the debt. This is the worst case scenario.
THanks, Good to know. In that sense it is pretty much like equities then. The only risk is the 2nd order impacts like tenant losing job and moving out etc.
But if your house price drops below the loan amount - the bank doesn't issue an equivalent of a capital call or margin call? Their collateral just dropped 20% in value..
So now I see the risk on the bank side for low down payments. Granted the buyer would probably want to keep their home because the only other option is declare bankruptcy? and the bank would firesale the house?
So we all know housing will dip/drop at some point. What happens to your equity in situations when you put down 5% vs when you put 20% down?
- Buy a 500k house and put 5% down (25k) and the next day housing prices crash and your house is now worth 400k.
- Buy a 500k house and put 20% down (100k) and the next day housing prices crash and your house is now worth 400k.
in the first case you are "underwater", correct? What does that mean exactly and what kind of real life implication does each case have assuming you keep paying your mortgage and have the same rental cashflow coming in?
If you keep the property it has no effect.
If you try to sell the property you lose your equity. When you are underwater it means you can't sell it for as much as you owe on it and you have to bring money to closing to cover the deficit. Keep in mind it costs you about 8% to sell. So, if you sell at $300,000 it will cost you about $24,000 between real state agent fees, title, concessions, escrow, etc.
For instance, your house used to be worth $350,000 but now it's worth $300,000.
if your loan is at $280,000 and you sell at $300,000 minus $24,000 in selling costs you net $276,000 - your loan payoff is $280,000 so you have to bring in an additional $4000 to close.
Thanks for the insight on selling costs.. wow
This is a great example of why percentages can lie to you.
In the first example (5% DP):
You would have a negative $75k equity.
In the second example (20% DP):
You would have $0 equity.
Hi @Joe Villeneuve! Can you explain further where these numbers came from? New to learning. Tryna understand:)
Property #1:
Buy = $500k
DP = $25k
Debt = $475k
Property value drops to $400k...you have a negative $75k equity.
Property #2:
Buy = $500k
DP = $100k
Debt = $400k
Property value drops to $400k...you have a $0 equity.
I see! Thank you for explaining 🙏🏽
@Chi Wen this is referred to as a "loss on paper" and it is just an unrealized loss. If you don't sell the asset, you lose nothing. That is why the best strategy is to sell assets when prices are high and hold/buy assets when prices are low. Of course markets don't operate like that. The frenzy that drives prices up means there are more buyers than sellers. The same frenzy drives prices down when there are more sellers than buyers.
If you are not selling, the main negative of being underwater is that you end up undercapitalized. This is a problem if you are seeking loans, because you are seen as owing more than your assets are worth. If you don't have other cash equivalents or assets, that can mane negative net worth. If/when a housing market turns bad, it becomes very difficult to borrow money, even harder if you have low or negative net worth.
If you are forced to sell when you are underwater, you may be forced to short sale the property. That is when you sell a property for less than you owe. In most states you become personally liable for the difference. In a serious enough situation, you may be forced to file bankruptcy to get out from the debt. This is the worst case scenario.
THanks, Good to know. In that sense it is pretty much like equities then. The only risk is the 2nd order impacts like tenant losing job and moving out etc.
But if your house price drops below the loan amount - the bank doesn't issue an equivalent of a capital call or margin call? Their collateral just dropped 20% in value..
So now I see the risk on the bank side for low down payments. Granted the buyer would probably want to keep their home because the only other option is declare bankruptcy? and the bank would firesale the house?
This is why banks generally require 25% down for investment properties. They have little risk that the property will net more than the loan amount in a fire sale situation. Banks don't do anything if the value drops below loan amount, unless it is a HELOC in which case they may freeze or reduce the credit limit. As long as you are making the payment, the bank doesn't care.