Saturday, May 22, 2010

Trivia Question


Q: You purchase a house for $400,000. Four years later, the appraised value of that house has fallen to $200,000. How much money have you lost?

A: Not a red cent.

At least that's the way I see it, as I explain in comments on this post by Jonathan Wilde at the Distributed Republic. My most recent comment there either got eaten or is still in an approval queue, so I'm going to reproduce the key points here:

You bought the house for $400k. Maybe you paid cash for it, maybe you took out a mortgage. That's not especially relevant to my point, as I'm not arguing for or against "strategic default" just this instant.

You have the house.

If the price at which the house will sell has gone down from $400k to $200k, you've lost nothing -- unless you sell the house.

Even then, your loss is mitigated by the equivalent rent you'd have paid if you hadn't bought a house, less the expenses you pay that a landlord would have paid if you were a renter. The "Bruce Williams Standard Rent Formula" is 1% of the purchase price of the house per month (that's what Williams tells landlords to charge). So, four years at $4000 per month (this assumes you'd have rented something equivalent to what you bought). That's $192,000 you've saved, less property taxes and improvements/repairs that you'd have expected the landlord to make. Call it $100k, which reduces your purely hypothetical (unless you sell the house) loss by half.

If the price at which the house will sell has gone down from $400k to $200k, something else has gone down, too: Your property taxes. (Assuming that your local government appraises with reasonable frequency and accuracy; not a safe assumption, of course, but anyhoo ...)

Now, about "strategic default" ... even if you consider the house an "investment" rather than a "domicile," and even if you take a bath on that investment, the bank didn't sign on to be your co-investor and take your loss with you. They just lent you the money to make the investment yourself. Your obligation to repay the loan is, it seems to me, independent of whether or not the investment turns out to have been wise.

I can understand defaulting on a mortgage if you just have no other choice -- you're broke, busted, can't make the payments -- and if that happens, then the bank's recourse is to take the house from you, make as much of their money back as they can from it, and put a king-hell dent in your credit score.

But walking away from a mortgage that you voluntarily entered into, that you can pay, on a house that you decided to buy and that you do in fact do have possession and use of? Guys, that's just bullshit.

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