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HELOCs Drag Underwater Borrowers Down

Negative equity risk remains high. CoreLogic data show a slight decrease in the percentage of mortgages with negative equity is not significant once the negative effect of home equity extraction and sluggish economic recovery forecasts are factored in.

At March 31, 27.7% of all residential properties had negative equity or near-negative equity mortgages, compared to 27.9% in the fourth quarter, according to CoreLogic. It means at the end of the first quarter only 200,000 borrowers no longer are “underwater” while another 10.9 million homeowners, or 22.7%, still owe more on their mortgages than their homes are worth, down from 11.1 million, or 23.1%. At March 31, an additional 2.4 million borrowers had less than 5% equity, referred to as near-negative equity.

CoreLogic chief economist Mark Fleming reiterated that many borrowers in negative equity are “able and willing to make their mortgage payments” unless they are impacted by an income shock such as job loss, divorce, or death, that “much more likely” would increase risk of foreclosure or a short sale.

Economic indicators that point to a “slow yet positive economic growth” may slowly reduce the risk of income shock and negative equity risk since it can occur because of a decline in value, an increase in mortgage debt or a combination of both.
It is a vicious circle.

Fleming expects the existence of negative equity for the foreseeable future will hold back sale and refinance activity weighing on the housing market recovery.

Declines in home prices combined with borrower equity extraction “significantly increased the risk” of a negative equity position. At the end of the first quarter only 18% of borrowers with no home equity loans were underwater, compared to 38% of borrowers with a HELOC. Currently 4.5 million, or over 40% of all negative equity borrowers, have home equity loans.

The report finds the incidence of home equity loans increases “the probability of a negative equity position and the severity of that position” as shown in the average negative amount.

Negative equity borrowers without home equity loans are upside down by $52,000, compared to an average of $83,000 for a negative equity borrower with home equity. Ultimately HELOCs negatively affect a borrower’s loan-to-value ratios and increase their probability for default. Generally if the current combined loan-to-value ratio increases, the default rate also goes up. For example, underwater borrowers with home equity loans and CLTV up to 115% the default rate is slightly higher than for those without a HELOC. The relationship reverses slightly for borrowers with severe negative equity at 115% CLTV or above.

The effect of HELOCs and CLTV aside, according to CoreLogic, along with findings from other reports including the Joint Center for Housing Studies of Harvard University’s “The State of the Nation’s Housing 2011,” indicate geography will remain a strong factor going forward.

JCHS reported that foreclosures are concentrated in just 10% of neighborhoods across the country that accounted for nearly 50% of all foreclosures in 2010. It concludes that millions of properties with negative equity, elevated vacancies and foreclosures “place downward pressure on prices especially in the hardest hit areas.” These findings indicate slight improvements in the percentage of underwater homes in the hardest-hit areas cannot be seen as a sign of recovery unless overall economic conditions and employment rates improve.

Nevada had the highest negative equity percentage with 63% of all mortgaged properties underwater. Nevada’s and the nation’s negative equity “capital city” also has not changed as Las Vegas led the nation with a 66% negative equity share.

The state with the second highest number of underwater properties is Arizona with 50%. It is followed by Florida with 46%, Michigan 36% and California 31%.

The negative equity share in the top five states was 39%, down from 40% in the fourth quarter, which means the average negative equity share excluding the top five states is much lower. It drops to 16% both in 1Q11 and 4Q10.

Nonetheless CoreLogic attributed the decline in the national negative equity share primarily to slight improvements in the hardest-hit states being Nevada at 2.7 percentage points and 1.3 percentage points in Arizona and Florida, while “the majority of states either remained unchanged or had minor increases.”