Negative equity critical threat to health of real estate market

A recent CoreLogic study reported that as of September 2009, nearly 11 million borrowers were “underwater” on their mortgages. As I’m writing this blog, there are even more borrowers swimming and trying to stay afloat.

Most economists agree that about 25 percent of all homeowners in the U.S. have negative equity in their homes. In fact, some reports claim the percentage is as high as 33 percent; others show it at 21 percent.  The loss in residential property values nationwide is estimated at about $500 billion for 2009 and at about $5 trillion since the 2006 peak. No wonder one of every four borrowers owe more than their properties are worth, especially given the low down payments used in many markets prior to the collapse.

Negative equity is proving to be a key indicator of trouble for housing markets, if not the most critical element of the housing crisis. Here’s why:

• Research shows that having negative equity is a very strong predictor of a forthcoming default
• Often, the default and subsequent foreclosure are “strategic” (i.e., the homeowner chooses to walk away)
• Foreclosures continue, providing additional downward pressure on prices and increasing the number of  households with negative equity
• Even if mortgage rates remain low (although most observers expect them to begin to rise in the months ahead), negative equity will prevent owners from treating the house as a valuable asset. Refinancing is generally out of the question.

Pennsylvania residents may be somewhat reassured that our state’s experiences with negative equity are much less than in the five hardest hit states: in Nevada, 65 percent of mortgages are underwater; in Arizona, 48 percent; in Florida, 45 percent; in Michigan, 37 percent; and in California, 35 percent. Many of the borrowers in these states made their situations worse by using option ARMs with negative amortization provisions, thereby increasing their mortgage balances over time.

We are not out of the woods yet. Until prices reach a solid bottom and cases of negative equity subside, the housing crisis will continue. It turns out that falling property prices over an extended period is perhaps the most devastating element in the residential housing market.

Related posts:

1. Podcast: Economy needs to rebound to strengthen real estate market
2. Real estate 2010: We’re not in Kansas anymore
3. Jaffe predicts home sale activity may increase in 2010

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This entry was posted on Wednesday, February 17th, 2010 at 6:05 am and is filed under Economics. You can follow any responses to this entry through the RSS 2.0 feed.