"Underwater" in the Housing Market

American Century Investments

March 9, 2010

In two recent Weekly Market Updates, we covered one aspect of the many challenges facing the U.S residential housing market: Rising delinquency and foreclosure rates on home mortgages (week of February 1st), and what the government has done and is attempting to slow or reverse these trends (week of February 8th). Last week, First American CoreLogic, a provider of mortgage analytical services to financial institutions, released a report on another dimension of the housing problem, its quarterly analysis of negative equity mortgages.

The term “negative equity mortgage” describes a situation in which the borrower owes more on the mortgage than the current market value of the home they bought. With the bursting of the housing bubble beginning in 2007, the number of these mortgages (also called “underwater” or “upside down” mortgages) has increased substantially. While homeowners with negative equity mortgages often continue to make payments (i.e. no delinquencies or foreclosures), there is a rough correlation between how badly their mortgage is underwater and the likelihood or risk they may simply cease payments, walk away from both the home and mortgage, and begin a foreclosure process.

The First American CoreLogic quarterly survey relies on actual banking data for the outstanding balances on residential mortgages, and their proprietary analytical software for data estimating the current market value of homes based on a number of factors including recent sales prices. It includes 47 million residential properties with mortgage values ranging between $30,000 and $30 million in 44 states. They estimate their study accounts for over 85% of all U.S. residential mortgages.

A National Snapshot

The chart below summarizes their findings for the fourth quarter. All mortgages have been placed into categories of solvency as shown on the vertical axis of the chart. A positive number (e.g. +10%) means a home’s estimated market value is 10% greater than the balance owed on the mortgage. A negative value (e.g. -15%) means the home’s value is 15% less than the balance owed on the mortgage (i.e. an “underwater” mortgage). First American CoreLogic calls the category of 0% to +5% home equity “near negative” because these mortgages lie very close to the line of becoming negative equity (or underwater) mortgages on homes.

The two horizontal axes at the top and bottom of the chart measure the value for each bar (i.e. each category of mortgage solvency) by both the percentage of all mortgages and the absolute number—both based on a total mortgage count in the U.S. of 47 million.

Source: First American CoreLogic 4th Quarter Survey of Negative Equity. See www.loanperformance.com

Notes:

The Percent of Owners’ Equity in Home is the difference between the estimated current market value of the home less the amount of the mortgage outstanding divided by the amount of the mortgage outstanding.
The numbers included within each bar report the actual percentage or absolute number of mortgages in each category according to the upper horizontal axis (percent) and lower horizontal axis (absolute number).
Analysis does not include homes without mortgages.

As the chart shows, the good news is that approximately 71% of all homes with mortgages in the U.S. have positive equity of at least +6%. The other side of the coin, however, is that approximately 29% of all homes with mortgages have either negative equity or near negative equity. Most troubling is that 13% of all homes with mortgages have at least -20% negative equity.

To put these numbers in dollar terms, the aggregate value of negative equity (the difference between estimated current home value and the value of the mortgages outstanding) for homes with underwater mortgages was approximately $800 billion in the fourth quarter, up from approximately $750 billion in the third quarter. On a per home basis for underwater borrowers, this equates to average negative equity of -$70,700 per mortgage in the fourth quarter of last year, which is up from -$69,700 in the third quarter according toe First American CoreLogic.

Negative Equity by State

While no state is immune, the problem of negative equity mortgages is not the same across the nation. And perhaps the differences between states (and the challenge) are probably best captured by the most severe category—mortgages with at least -25% home equity. As the chart below illustrates, five states (Nevada, Arizona, Florida, California and Michigan) each have at least 15% of all their residential mortgages outstanding in a position where the estimated home value is at least 25% lower than the balance on the mortgage outstanding.

Source: First American CoreLogic 4th Quarter Survey of Negative Equity. See www.loanperformance.com

Notes:

The Percent of Owners’ Equity in Home is the difference between the estimated current market value of the home less the amount of the mortgage outstanding divided by the amount of the mortgage outstanding.
Analysis does not include homes without mortgages.

These figures should be evaluated in light of both the total number of residential mortgages in each state and the aggregate value of all mortgages outstanding (see the data table below the bar chart). In Nevada, with 53% of all its residential mortgages being at least 25% underwater, there are only about 600,000 mortgages (the state has only 2.6 million residents, less than the population of most large U.S cities). Arizona is a similar case with a somewhat lower percentage of mortgages deeply underwater but a higher number (1.4 million) of total residential mortgages in the state.

On the other hand, Florida and California are much bigger challenges given the number of residential mortgages (over 11.5 million combined) and the aggregate value of mortgages (slightly over $2.8 trillion—which is approximately one-third of the total value of mortgages outstanding for the entire U.S.). Michigan presents a different story: 16% of all mortgages are at least 25% underwater. This is not due to the type of speculative excess we saw in the housing markets for Florida, California, Arizona and Nevada (the “Sun and Sand States”), but due to having the highest rate of unemployment (14.6%) for any state in the country. Other populous states such as Georgia, Ohio and Illinois, each with populations of at least 10 million, are experiencing problems of relatively high negative net worth for homes with mortgages in their states.

The Economic Impact of Negative Equity

There are at least three reasons why homes with negative or near negative equity are an important concern, not just for those individuals, but for the purpose of developing economic policies that ensure the current economic recovery continues:

Negative equity is a predictive statistic for future home foreclosures. At some point in the process of paying on a severely underwater mortgage, the homeowner may come to believe the better option is to default and walk away. While economists have been somewhat surprised by the low rate of these so-called “strategic defaults” so far, when they occur they impact mortgage investors, the government (if the mortgage is guaranteed) and home prices (by adding new supply to the market).

For many mid- to lower-income people, their home has been an important if not the largest source of retirement savings. With home prices down by 25% since the start of the financial crisis in some markets, this affects not only people whose home equity has been wiped out but those who, even if they may still have positive equity in their homes, have a lot less than three years ago.

Some economists argue that negative equity decreases labor mobility at a time of seriously high unemployment. America has long been known as a land of both opportunity and mobility. If owning a home with negative equity constrains some people from looking for employment in other regions or states, the impact will be a slower drop in unemployment as new jobs are created.

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