Subprime meltdown creeps toward prime mortgage holders

It's no secret that subprime mortgage holders have been feeling the pressure this year. So far we have not heard too much news regarding regular mortgage holders, but a new report is showing that even the average mortgage holder is starting to feel the pain of a weak housing market.

For most of this year, the headlines have revolved around foreclosures involving high-risk subprime loans. We have seen reports of falling home prices, but so far prime mortgage holders have been cruising along feeling pretty safe from the mounting real estate concerns. What they had not counted on was falling home prices pushing their outstanding mortgages "underwater."

What exactly does it mean to have a mortgage go underwater? Simply put, it is the term used to describe a mortgage where the underlying property value is worth less than the property in question. What has led to this is the fact that on average, property values nationwide are running 5 1/2% lower than they were this time last year, and many markets across the nation have seen much larger declines in values.

The result is not a pretty picture. If you bought your new home within the last 12 months, there is a 15% chance that your mortgage is now underwater. The figures run higher for homes purchased two years ago, and are a poor comparison to the only 2% chance of being underwater if your home purchase took place five years ago. As it turned out, some people just had poor timing in buying their new homes.

The good news? Well, as long as you can afford your current mortgage payment, then the current situation should not cause you too much concern. You will simply need to ride out the current trend and wait for property values to pick back up again. On the other side of the coin, should you find yourself in a situation where you are going to be forced to sell your home and relocate elsewhere in the country, you will be forced to deal with the fact that you will not be able to sell your home for what you currently owe on the loan.

How much is too much? The next logical question is when will you reach the decision to just go ahead and cut your losses. If you owned a stock that fell 10% or 15% you would probably start to ask yourself if you should sell and cut your losses. The same question is going to be asked regarding home prices for those homeowners that worry that the market is not going to rebound from its current level.

What are a couple ways that you can safeguard your investment in your current home?
  • Avoid investing sizable amounts of money into your home. This goes against almost everything we have ever been told regarding our homes I know. We have been trained to believe that investments in our homes will pay for themselves, but if your mortgage is already underwater, this is not necessarily the case, and it could actually just add more money to your eventual loss.
  • Instead of investing money into home improvements, use that money to increase your emergency funds. Should the market continue to deteriorate, you are much better off having a nice cash cushion than you are with a new sparking bathroom.
  • Consider putting off extra mortgage payments for a while. When home values are higher than your mortgage value it is ALWAYS a good idea to pay a little extra each month on your principal. An extra payment a year can lower a 30-year mortgage as much as 12 years, but if your mortgage is underwater then you will need to think twice about paying down that principal and think about putting that money somewhere a little safer. After all, if you are forced to sell your home below the mortgage value, that money is not coming back to you.

The best advice is that if you plan to stay in your current home for the long term and can keep up with your current payments, don't stress about the current situation too much. Chances are that the market will bounce, but you do have to accept that the market is going to get worse before it gets better. Don't panic! Consider your options, put a little extra money aside in your emergency fund, and just ride it out.

[Photo : nate steiner]

Michael Fowlkes has worked as a stock trader for seven years and spent the last two years working as an analyst for the online investment advisory service Investor's Observer.

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