Giant Communist Robot wrote:
Not sure what you are trying to say.
I don't know much about real estate. Isn't the owner's equity equal to the value of the property minus the mortgage? In the example Shapley and I gave the new owners would have negative equity and unless they had enough assets to cover a cash purchase wouldn't they owe more than they own? Where's our real estate experts when you need them?! Lurking?!
The mortgage is loaned against the entire property. If the homeowner defaults, regardless of their accumulated equity, the bank assumes ownership of the entire property.
Let us say, for example, I purchase a house of $100,000. The bank, under the old rules, could only loan me $80,000, against which I 'put up' the entire value of the home, or $100,000. Theoretically, therefore, the bank assumes little or no risk in making the loan. I, however, risk my entire down payment of $20,000.
Let us say that, after a few years, I have paid $5,000 in principal, and my area is hit with an economic downturn, such that the value of the house declines by $10,000, and I lose my ability to pay my mortgage, so I default. The bank forecloses. As a result, they assume a house now worth $90,000, of which they have $75,000 invested (the original $80,000 minus the $5,000 principal paid).
In a normal market, they would then sell the home. The would be content to sell it for the $75,000 investment, thus 'breaking even' (which ignores the interest they've earned on the loan prior to my default). However, selling it less than appraised value lowers the value of other homes in the neighborhood. This is due to the fact that appraisals take into account the market history of homes in the area. Since lowering home values is not in their best interest, thus will endeavor to try to sell the home at or near the market value of $90,000.
Let us say that they find a buyer at $85,000. They have thus recovered their initial loan, and have $10,000 over and above their investment. Depending on State law and the terms of the loan, they may or may not be obligated to return to me some or all of that $10,000 excess over my loan, which offsets some of my equity loss.
The bottom line, however, is that they bank 'holds the note' on the full value of the home, which would theoretically always be greater than their investment. Homeowners are obligated to insure mortgaged homes against loss due to fire, etc., further protecting their investment. In many markets, the lender will escrow taxes and insurance,in order to ensure those obligations are met as long as the home remains under mortgage.