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Originally Posted by DrTiTus
I may be misinterpreting you - but even if the "value" of your house drops below the size of your mortgage, you don't suffer any instant repercussions. You don't immediately become bankrupt, as far as I am aware.
People agreed what they were happy to pay for their house, and they agreed what they were happy to borrow. They agreed to continue to pay for n years, and life goes on, assuming they still have employment. At the end of their mortgage term, they've paid far more than their house is worth, it's true - but this is the case with most mortgages, and people are doing everything they can to get one!
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Yeah, I was kind of hedging my words to some extent. I'm not sure exactly what happens in that scenario, you could well be right about all of that. If you are, it only really makes my point stronger though. I'm not entirely sure, I think the reasoning for the concern about a drop in market value goes something like:
If house prices come down, then people do not need such large loans any more.
If loans are smaller and incomes stay the same then people can afford larger repayments relative to the size of the loan.
If repayments stayed the same demand would probably out-strip supply, and prices would have to go back up.
Therefore,
Interest rates must increase if house prices are to decrease.
The problem comes about, then, when people who have taken out really huge mortgages on expensive properties which they could service under low interest conditions suddenly find themselves facing an interest hike, and the size of the repayments shoots up.