What to do with the USA Underwater Home Loan?!

I had an acquaintance recently post this on a forum i visit regularly…they’re from the USA, and their home is “underwater”, meaning the market value of their house is worth less than the current debt principal (net amount) they took out for it…ouch…but pretty common in the USA at the moment 😦

Anyway, here’s my two-cents-worth comment to them, for anyone that cares!

They asked:

There are some opinions that United States is headed towards (hyper)inflation.

My wife and I bought a condo in 2007 in San Francisco Bay area, just before the housing market crashed. Now our mortgage is about 20% “underwater”. We tried modifying with President’s Obama program, but got rejected. Tried refinancing, but got turned down as well. We are now contemplating a strategic default, whereby we simply stop paying our mortgage and eventually move out to a rental.

What I read about other countries that experienced inflation is that salaries kept up with inflation, and people who owed money eventually paid off their loans with “cheaper” dollars.

Do you think is makes sense for home owners that are significantly underwater to default now, or should they simply wait for inflation, and pay off their houses with cheaper dollars?

I responded (or, rather, quickly thumped out something that hopefully wasn’t TOO quick…):

Dear (person),

Keep in mind that (at least in my humble opinion) if central bank rates are near-zero, then they are unlikely to do anything to try and counter inflation in the short to medium-term, should it start to become “a problem” to them….which is “good”. This is because they will, at least initially, be of the opinion that cheap-debt for stimulus and economic recovery is more important than the “slightly higher inflation rates”.

BUT, i would expect that PRIVATE lenders might want to preserve the present and future value of their loan to you (or anyone) by increasing their interest rates – ie. moving interest rates independently of the Central Bank.

Of course, if the Central Bank is printing lots of money and causing monetary inflation (as opposed to consumer price inflation), then that same bank can just go and get some really cheap money for near-zero interest….

…but maybe you can see where this is going…

If SOMEONE doesn’t even TRY to express that the money they’ve lent to someone is actually worth anything to them in terms of a return, by giving it a “decent” interest rate (ie. return), then NO ONE will value the money…

…and if no one values the money, then what good is it as a medium/carrier of value?? Isn’t that the whole purpose of money anyway!?!?!

This is a near-certain recipe for high, then hyper-inflation; that is: central bank rates are near-zero, and private lenders don’t value their loans with “decent” interest rates.

It was cheap to produce (Central bank); cheap to acquire (private lender); cheap to receive (borrower) …. so the money is just “cheap”, and you need a lot of cheap stuff to hold value…if it holds any value.

In my honest opinion, this is a perfect recipe for hyper-inflation in the medium to long-term.

Possible result to you, in relation to your question?

If you think private lenders will just give you cheap loans, then you should be right sitting it out and waiting for inflation – and possibly hyper-inflation – to take chunks out of you debt. Since you are in the USA, and operate in USD, if this all happens, your USD this will rapidly devalue your currency and possibly destroy it altogether (hyper-scenario).

BUT, if you think that private lenders will actually try to VALUE their money (ie. value medium) accordingly (as i personally think they should!), then they will jack up interest/lending rates quickly, and probably to “very high” levels. If you have debt, this will really hurt.

The truth is, if central banking is to survive, then – in my honest opinion – it needs to preserve the value of the “money” it distributes. That is, as much as they want to “stimulate” their economy to acquire really cheap debt and keep the debt-wheels-a-turning, they are going to have to choose between they and their government’s mandate to “control”, and trying to preserve/stimulate the economy’s “health”…

…and i think Central Banks and their governments WILL choose control in MOST circumstances, in most countries (else lending reverts back to a free-market, decentralised system of each lending entity choosing to value its own lending-money to suit its own purposes…); or they could try and implement another currency altogether, but good luck getting people to actually value THAT one, too, with their memory of the previous effort (read: FAILURE) still etched powerfully into their minds!

Hence, i think that they, the Central Bank of said country, and associated government will – somewhat reluctantly – choose to “save” the perception-value of their currency and “save” their “control”, and start raising interest rates fairly quickly (by historical “stable economic” standards), and start “chasing inflation” again. This could go hyper, should it happen.

Thing is, when central bank rates go up, so do private lender rates; so you could have a double-whammy private lending rate increase scenario: private lenders choosing to value their money, and central banks trying to value the currency…both at once. 😛

When will this happen? Dunno, really. Could be 2 or 5 years; could be 10 or 20….but some sort of “nasty” scenario is probably hard to avoid, given that there is “no where to run” now, globally…everything is affected and intertwined…bummer!

If i were you, speaking for MYSELF, i would minimise my debt position, sell-up, rent, and pay off the outstanding loan-remainder ASAP. But then I WOULD be without a house “of my own”, and that has its own problems. Or perhaps i could provide my lender with an ultimatim where i renegotiate what i can actually afford to, or i will default!? (another reasonable option?)

Or, you could default (USA style, not Aussie style – different consequences), and be totally debt-free (but with a bad debt record??)

You need to make up your own mind; but either way – minimising debt by paying off principal in the short to medium term, or selling up or defaulting in the extreme (?) – minimising debt exposure is probably a good idea (given my assumption about eventual central bank and subsequent private lender actions…and i could be totally wrong!)

Hope that actually made things clearly rather than more confusing! 🙂

Wow that was a whirl of thought, and now i am dizzy…

…yes, i hope that actually DID make sense!

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