Trillions in Mortgage Debt Is Likely Underwater

New York-Experts at Moody's Economy.com now believe that one in six homeowners owe more debt on their home than the house is currently worth.

Moreover, economists at the firm currently expect home prices to drop another 10% before the bloodletting is over, putting even more homeowners under water and stalling prospects for a near term recovery.

When will that occur? Economy.com predicts that prices will hit bottom next summer, but will not start to meaningfully rise until "the middle of 2010," consumer economist Scott Hoyt told MSN. One reason the housing problems are likely to persist so long is the prevalence of pay-option ARM loans, which allow negative amortization in the early years. When those loans convert to full payments, many borrowers will see staggering increases in their monthly payment. That will be a continuing drag on the housing recovery, Mr. Hoyt said.

Peak to trough, Economy.com anticipates that home prices will fall 30% from a peak in 2006. So far, Mr. Hoyt says, prices are down about 20%, citing Case-Shiller data.

There are an estimated 75 million homes in the U.S., and the average home value is just shy of $200,000 nationally. If 16% of homeowners are under water on their mortgage, that would put roughly $2.35 trillion in home loans at risk. Total mortgage debt in the U.S. is estimated at roughly $10 trillion, according to this newspaper's Quarterly Data Report.

But that estimate, made by MSN, is probably on the low side, since the most severely depressed markets currently are in relatively high-cost areas such as California and Florida.

Still, Mr. Hoyt said that even homeowners who are "under water" on their home loan are not likely to default unless they face an additional trigger, such as job loss or a loan reset, he said.

"If they took out a fixed-rate mortgage with payments that are comfortably within their budget, and they're not losing their job and they have no reason to move anytime soon, chances are they will ride it out," Mr. Hoyt said.

Mark Zandi, the chief economist at Moody's Economy.com, has estimated that total mortgage losses will be about $650 billion.

Signs of market stabilization have been few and far between. In July, Case-Shiller's data showed prices down 16% from one year earlier. David Blitzer, chairman of S&P's index committee, said that while there is no evidence that housing markets have hit a bottom, the rate of price declines appears to be slowing. Prices are down on a year-over-year basis in all 20 of the major metro areas tracked by Case-Shiller.

"Little positive news can be found when cities like Las Vegas and Phoenix report annual declines as large as 29.9% and 29.3%, respectively," Mr. Blitzer said.

Most home sales data remained bleak in July and August. But a measure of pending sales from the National Association of Realtors did suggest that in September, buyers were starting to take an interest again.

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