You are buying a new home. How much do you want to borrow for your home loan? For many, they need to borrow as much as they can. But for some, the question is a discretionary one.
Worst Case Scenarios
The answer to the question may be in looking at a worst case scenario, which was actually a common scenario during the real estate crisis of 2008 and beyond. What happens if real estate values plummet or stagnate? What if you lost your job, and were unable to pay your mortgage?
This is where the value of your house compared to what you borrowed matters. Assume your house is worth $400,000, and you borrow $380,000. Even a slight fluctuation in the economy, or the real estate market, could lower the value of your property to less than what you owe—a situation that is often called being “upside down.”
If you are employed, or making your mortgage payment, you may be able to weather the storm. Just continue paying until the economy corrects itself and the value of your home goes back up. However, if you were to lose your job, you would have a real problem.
The sale of your home at foreclosure is bad enough. It is made worse when the value of your home is less than what you owe. The balance could become a money judgment (called a deficiency judgment) against you.
Let us assume that your $400,000 home is now only worth $330,000, but you still owe the mortgage company lender $370,000. The home is sold at foreclosure, and $330,000 is paid to the lender. There is still a $40,000 balance remaining.
The lender does have to jump through some legal hoops, such as filing a deficiency judgment case against you, which you can challenge. However, if the deficiency judgment is granted (in this case, for $370,000-$330,000, or $40,000), there is a $40,000 judgment now entered against you. You have both lost your home, and incurred a serious debt.
How Much to Borrow?
Let us go back in time, to your real estate closing. Remember how you borrowed $380,000? Now let us pretend you borrowed $330,000 on your then-valued $400,000 home. Now, you have a $70,000 “cushion,” where your home could lose $70,000 value, and if you could not pay your loan, and ended up in foreclosure, you would at least not have a money judgment entered against you because the house would be worth about what is owed on it.
Additionally, borrowing less money makes the payment smaller, which makes it less likely that you would be unable to pay your mortgage payment in the future.
Of course, many of us may not have an option—we need to borrow what we need to borrow. But if there is a choice, thinking “worst case scenario” may be a good idea when deciding how much to borrow.
We help homeowners make legal and practical decisions in real estate closings. Contact our real estate attorneys at The Law Office of Agnes Rybar LLC to help you with your real estate closing.