Loans go to zero. It happens in real estate, it happens in oil and gas, it happens in other places I'm sure. It's not especially common, but it happens.
It is common, but at the end of a cycle. The chances of second lien loans being worth zero are higher and higher as leverage increases. This is for two reasons:
1. The greater the leverage, the smaller the required downturn to turn everything underwater. With 5% down mortgages, a 5% decrease in housing values makes you underwater (esp once you consider transaction fees.)
2. The greater the under-water, the less incentive owners have to continue paying, especially in non-recourse jurisdictions where no bankruptcy is required. Owners do "jingle-mail" where they mail the keys to the bank (figuratively) and walk away without having to declare bankruptcy. The bank is left with the mess.
Freddie Mac is already pushing to do 2nd lien HELOCs (https://www.housingwire.com/articles/freddie-macs-proposed-h...) and Fannie is considering it.
People keep saying this, but the only time they can come up with examples are when the owner wants out of the property. In the case of a home loan, being underwater is meaningless if you're not going anywhere. Most people will continue to pay because they need a place to live. I have yet to hear of someone who was underwater on their primary home loan and decided to stop paying it and default just because. For an investment property I could see that happening. For the house that you plan to live in for the next 20 years? No.
Only if you have a real choice. Reasons people will default:
- Divorced, force seller; especially common as finances go downhill
- floating rate on 2nd mortgage/HELOC is no longer affordable
- Lost job, have no money to pay mortgage. defaults
- Job change with lower income. Have money, but not enough to keep up with payments
- property taxes re-assessed, no longer affordable. tax liens pile up on home
