With home prices aggressively dropping a big concern amongst some investors holding mortgage backed securities is that some of the houses will be worth less than what the mortgage borrower owes. Explained by Nouriel Roubinin in his congressional testimony [PDF]:

In most US states mortgages are a non-recourse loan; thus, if a home owner defaults on its mortgage the bank take over the collateral - the home - via foreclosure but once that happens it cannot go after the borrower for any difference between the value of the original mortgage and the current value of the property.

Some home owners may get out of their mortgages simply by missing payments and mailing their house keys to the bank, a process that is known as jingle mail. It will damage their credit scores, but if they can’t keep up with the mortgage then those were going to get damaged anyway.

To mitigate the risk of homeowners walking away, the Office of Thrift Supervision is in the early stages of a plan to create negative equity certificates:

Under the regulatory agency’s proposal, still in its early stages, these borrowers would refinance into government-insured loans that cover the current value of their homes. The refinancing would pay part of what’s owed to the original lender. For the remainder, the lender would get what the plan’s backers call a “negative equity certificate.” The lender could redeem the certificate if the home is eventually sold at a higher price.

Hundreds of readers of the influential Calculated Risk blog are doubtful of the viability of such a program, as guessing a bottom in home prices is aiming at a moving target, especially with so many homeowners having zero equity or negative equity.

To appreciate how ugly the problem is, here are a couple charts. Click on either for a larger view.

A Healthy Fear of Fame

The internet makes it easy to become famous, even if that fame is for messing up, but the fame can crack relationships. Casey Serin, author of the popular I Am Facing Foreclosure blog, and owner of a $2.2 million debt, recently mentioned that he is shutting his site down in an attempt to save his marriage.

Anyone who gets as big in the hole as he did at that young of an age will eventually likely wind up on the other side as well. Best of luck Casey!

A Growing Trend Amongst Home Owners

Foreclosures are more common than some would lead you to believe. A recent Moody’s report suggests that fall 2011 forclosure rates may reach 20%, and that does not even include the foreclosures that occured before that point in time:

Subprime ARMs issued during the last three months of 2006 could fare worst of all, with a projected foreclosure rate of just under 20 percent during the fall of 2011.

That would mean a full one in five owners still paying off subprime ARMs from late 2006 - about 12,000 in all - would lose their homes. Many others from that group would have already lost their homes to foreclosure in the previous years.

The Cost of Borrowing Money

Home loans are a calculated risk against your job, your future, and the economy. If the economy gets hot and inflation sets in, rising interest rates may cause your mortgage payment to exceed your free cash flow. If the economy goes into a recession and the job market stumbles or something happens to you and you lose your job you may also lose your home.

If you don’t understand how shifts in money supply can effect leverage, the cost of currency, and mortgages rates it is worth watching the Money Masters DVDs.