Nearly One in Four Mortgages Are ‘Under Water’

Nearly One in Four Mortgages Are ‘Under Water’
April 25, 2011

Real estate news is unpleasant these days. The National Association of Realtors reported the volume of existing home sales fell 9.6 percent in February, following three months of seasonally adjusted volume increases.

The median national price in February, $156,100, was 5.2 percent below the median in February 2010. The Realtors noted 33 percent of sales in February were cash transactions, no surprise given the combination of low prices and a punky mortgage market.

CoreLogic, a financial data company, reports information on negative equity on a quarterly basis. Its most recent report, dated March 8, reported on underwater mortgages through the end of 2010. The numbers aren't good: 23.1 percent of residential properties with a mortgage were worth less than the amount owed at the end of 2010, an increase from 22.5 percent at the end of the third quarter of last year. Equity was most negative in states that had the most real-estate speculation: 65 percent of proprieties in Nevada were underwater, along with 51 percent in Arizona and 47 percent in Florida.

So much for the notion that real estate is always a great investment and the best way for the middle class to build equity.
 
Program Failing So Far
The negative equity issue persists despite the Home Affordable Foreclosure Alternatives (HAFA) program, which the federal government initiated in April of 2010. The goal was to stimulate the housing market by eliminating the homeowner’s responsibility for any shortage between the amount of the mortgage and the sales price of the house.

However, the possibility of fraud was a concern because it would be a simple matter to engineer a short sale to a confederate who could “flip” the property by quickly selling at a profit; housing prices are notoriously subjective, after all.

Hence, HAFA comes with a long list of requirements. To be eligible, a homeowner cannot qualify for the federal Home Affordable Modification Program (HAMP), have failed a HAMP trial, or be delinquent on a HAMP modification. The monthly payment must be more than 31 percent of a borrower's gross income. Thus this is a program for someone who is close to losing a house and has the patience to go through the application and documentation process.
 
There are two reasons people owe more than their house is worth. The first is that the value of the house falls. The second is that the mortgage may have been greater than the value of the house, which may happen if a home-equity loan is involved or if the borrower has skipped payments.

Falling Volume and Prices
Negative equity keeps people from selling their houses, which is why the National Association of Realtors data show both falling volume and falling prices. But it's mostly an issue for those who need to sell. Many underwater homeowners are unhappy about their situation, but if they like where they live and can pay the mortgage, the advantages of sticking it out often are greater than the hassles of selling, especially for those who are only slightly underwater.

In fact, many homeowners may not realize they are underwater, as hope about prices springs eternal.

The problem of falling home prices may persist as long as people are reluctant to show a loss. Stock market investors are notorious for refusing to sell losers, which behavioral finance experts chalk up to loss aversion and regret about the initial purchase.

Those who refuse to move until prices are higher place a damper on demand, but it's hard to say they are being unreasonable. Still, they are contributing to low volumes and low prices, affecting everyone.

Ann C. Logue (annielogue@gmail.com) writes from Chicago about business and technology issues. Her latest book is Emerging Markets for Dummies.