Thursday, February 12, 2009

The very real crisis in the neighborhood- enough to turn the stomach

The economic crisis is really having a social upheaval between oneself and ones neighbors to an extent it did not before. Given the collapse in the housing market, I illustrate by way of an example to make the point about the changed economic circumstances arising out of changed expenditure.

Mr X and Y are neighbours, living next to each other on a new housing development to which they moved two years ago, each paying US$1M for their lovely home with all mod cons. Mr X worked for a mortgage brokerage, earning US$100K gross, and Mr Y worked for the Government also earning the same. They both put down 10% on the house and borrowed the rest from the same lender, paying the same monthly interest on the mortgage of $4,500 a month. This took a chunk out of their monthly income. When the recession hit and the bottom fell out of the mortgage brokering business, Mr X lost his job, and went on unemployment benefit, being forced to foreclose on his home and walk away leaving the property with the lender. Mr Z bought this property at auction for US$500,000 with a down payment of US$100,000. His monthly mortgage payment is $2,000 and his income is US$50,000. The annual property taxes that Mr Y pays is US$10,000. It is based on the price paid at 1% and so Mr Z pays US$5,000. Due to the deductions and lower income Mr Z pays no taxes, while Mr Y pays US$5,000. Mr Y net annual income after mortgage interest and taxes is $31,000, while, Mr Z who earns half that has $21,000. A difference of $800 a month.

So Mr Y who sees his neighbor doing a job that pays less than half his, living next door, having paid half of what he did for the house a few years later, saddled with a mortgage that exceeds the value is in a negative equity position to add to his woes, while the lower income neighbor has a positive equity of the $100,000 down payment. What is Mr Y to do? Does he walk away in bankruptcy, that could jeopardize his job? And with no money to put on another home, will have to be a renter in a place of similar value but with a much lower rental than his current mortgage freeing some disposable income.

These are some of the real choices people will have to make, and with the temptation to walk away being so great, could exacerbate the mortgage crisis further, even by those who still have jobs, but are appalled at having to pay interest and capital on a borrowing that far exceeds the value of the home.

1 comment:

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