By Frank James
Nearly a quarter of the nation's homes with mortgages are valued for less than the amount their owners owe the banks holding their mortgage loans, according to a depressing new report.
The report by First American CoreLogic indicates that almost 10.7 million, or 23 percent, of all residential properties are "underwater" meaning they have negative equity. (If you want the entire report, you'll have to provide the company with your personal contact information, including your e-mail address.)
Nevada had the highest percentage of underwater homes at 65 percent. (It was 58.2 percent in March.) That 65 percent is just an eye-popping statistic. Since, as First American CoreLogic's report points out, being underwater is typically the precursor to foreclosure, it suggests the foreclosure crisis in Nevada and several other states will only get worst before it gets better.
Arizona was next at 48 percent, followed by Florida, Michigan and Calfornia.
Some of the reports key findings:
Nearly 10.7 million, or 23 percent, of all residential properties with mortgages were in negative equity as of September, 2009. An additional 2.3 million mortgages were approaching negative equity, meaning they had less than five percent equity. Together negative equity and near negative equity mortgages account for nearly 28 percent of all residential properties with a mortgage nationwide.
The distribution of negative equity is heavily concentrated in five states: Nevada (65 percent), which had the highest percentage negative equity, followed by Arizona (48 percent), Florida (45 percent), Michigan (37 percent) and California (35 percent). Among the top five states, the average negative equity share was 40 percent, compared to 14 percent for the remaining states. In numerical terms, California (2.4 million) and Florida (2.0 million) had the largest number of negative equity mortgages accounting for 4.4 million or 42 percent of all negative equity loans.
The rise in negative equity is closely tied to increases in pre-foreclosure activity. At one end of the spectrum, borrowers with equity tend to have very low default rates. At the other end, investors tend to default on their mortgages once in negative equity more ruthlessly: their default rate is typically two to three percent higher than owner-occupied homes with similar degrees of negative equity. For the highest level of negative equity, investors and owners behave very similarly and default at similar rates (Figure 4). Strategic default on the part of the owner occupier becomes more likely at such high levels of negative equity.
The bulk of 'upside down' borrowers, as a group, share certain characteristics. They:
-- Financed their properties between 2005 and 2008, with 2006 being the peak year where 40 percent of borrowers were in negative equity (Figure 5). Negative equity continues to be a problem even for 2009 originations as evidenced by a negative equity share of 11 percent and another 5 percent near negative equity.
-- Purchased newly built homes that are concentrated in a small number of states. For homes built between 2006 and 2008, the negative equity share is over 40 percent.
-- Relied on adjustable rate mortgages (ARMs)
-- Bought less expensive properties. The average value for all properties with a mortgage is $270,200, but properties in negative equity have an average value of $210,300 or 22 percent less (Figure 8). The average mortgage debt for properties in negative in equity was $280,000 and borrowers that were in a negative equity position were upside down by an average of nearly $70,000. The aggregate property value for loans in a negative equity position was $2.2 trillion, which represents the total property value at risk of default, against which there was a total of $2.9 trillion of mortgage debt outstanding.
So much of the average American's financial well-being is tied up in home values, it's hard to see how the economy gets back on track if this underwater condition persists through vast swaths of the nation.
The answer is for home values to rise significantly. But while the S&P Case-Schiller report released today shows home prices rose for the fifth straight month in September, home prices based on a national average are now at autumn 2003 levels, making for six lost years.