A home debtor has a large outstanding mortgage and limited equity. The debtor may have difficulty repaying the loan because of its size and the associated costs of home ownership, which can eat into available funds for paying down the mortgage. This can create a precarious financial situation where a home debtor is at risk of falling behind on payments and losing the home, or walking away from the loan to escape the obligations. Mortgage lenders monitor their customers carefully to identify high risk debtors.
There are numerous reasons why debtors may end up with low equity and a big mortgage. Some may have qualified originally for low equity loans, where they deposited a low percentage of the purpose price at the time of purchase. These home debtors may have received assistance through government agencies that insure loans, for example, to make it possible for low income people to buy real estate. If the mortgage payments are too high to realistically handle, the debtor can get into trouble on the loan.
Other home debtors may have built up equity, only to use it as the basis for a line of credit. These homeowners may take advantage of the equity they develop over time to access funds for home improvement, paying for college, and other activities. This drives the debt to equity ratio back up and can result in financial problems. The home debtor might, for example, lose a job and be unable to handle payments on the line of credit and the mortgage.
Such individuals may become house poor, a situation that can arise when the bulk of income is spent on a home. In addition to payments to service their debts, they also have to pay for taxes, insurance, and maintenance. Over time, a home debtor can be backed into a financial corner because the cost of the house outstrips the ability to pay and limited money can be placed in savings. The lack of equity in the home can make it hard to access credit to temporarily cover shortages, and this may result in foreclosure once the home debtor runs out of options.
Mortgage lenders can use formulas when they originate funds to determine how much house a borrower can afford. These formulas examine the given down payment and income to calculate a reasonable monthly payment, considering other expenses like insurance and taxes. Strict guidelines can prevent lenders from offering loans outside the reach of their customers, although this may not stop a borrower from receiving a home equity loan that increases the expenses associated with keeping the house.