The relentless slide in home prices has left nearly one in six U.S. homeowners owing more on a mortgage than the home is worth, raising the possibility of a rise in defaults -- the very misfortune that touched off the credit crisis last year.
The result of homeowners being "under water" is more pressure on an economy that is already in a downturn. No longer having equity in their homes makes people feel less rich and thus less inclined to shop at the mall.
And having more homeowners under water is likely to mean more eventual foreclosures, because it is hard for borrowers in financial trouble to refinance or sell their homes and pay off their mortgage if their debt exceeds the home's value. A foreclosed home, in turn, tends to lower the value of other homes in its neighborhood.
About 75.5 million U.S. households own the homes they live in. After a housing slump that has pushed values down 30% in some areas, roughly 12 million households, or 16%, owe more than their homes are worth, according to Moody's Economy.com.
The comparable figures were roughly 4% under water in 2006 and 6% last year, says the firm's chief economist, Mark Zandi, who adds that "it is very possible that there will ultimately be more homeowners under water in this period than any time in our history."
Among people who bought within the past five years, it's worse: 29% are under water on their mortgages, according to an estimate by real-estate Web site Zillow.com.
The majority of homeowners still have equity, and even among those who don't, many continue to make their mortgage payments on time. The financial-bailout legislation could at least "keep things from getting much worse" by helping banks avoid the need to tighten credit further, says Celia Chen, director of housing economics at Economy.com. Still, she expects housing credit to remain tight and home prices to decline in much of the country for another year or so.
Prices are back to 2003 levels in the San Diego and Boston metropolitan areas, and back to 2004 levels in Las Vegas, Los Angeles, San Francisco, Fort Lauderdale, Fla., and Minneapolis, according to First American CoreLogic, a data firm in Santa Ana, Calif.
Stephanie and Jason Kirschenman thought they were being prudent when they agreed in late 2004 to buy a new four-bedroom home in Lodi, Calif., for $458,000. They put a substantial 20% down and chose a loan with a fixed interest rate for the first 10 years. Two years later, they took out a second mortgage to pay off some bills.
At the time, the home was appraised for about $550,000. But a mortgage broker recently estimated its value at well below the $380,000 the family owes on it, says Ms. Kirschenman. "We were quite shocked," she says.
The Kirschenmans, who both work for a company that makes trailer hitches, thought about sending the keys to the lender. But their financial planner, Christopher Olsen, helped persuade them to stick with the house, noting that they could still afford the payments.
Others aren't so lucky. Among mortgages on one- to four-family homes, 9.16% were a month or more overdue or were in foreclosure in the second quarter, according to the Mortgage Bankers Association. That compared with 6.52% a year before and was the highest level since the association began such surveys 39 years ago.
Falling values have contributed to a sharp pullback in mortgage lending. In the third quarter, mortgage lending fell to the lowest level in eight years -- down 44% in a year -- says the publication Inside Mortgage Finance.
One reason is that as home values slip, growing numbers of would-be borrowers lack sufficient equity to refinance. The falling values also make mortgage lending look riskier to banks, spurring them to tighten credit standards.
Most mortgages in default were issued in 2006 and 2007, when lending standards were loosest and the housing market was peaking. Many who bought then made small down payments or none, so they had little equity in their homes from the start.
The performance of loans made earlier is getting worse, too, as price declines deplete the equity people built up. In Las Vegas, 6% of home loans made in 2004 are now 30 days or more overdue, up from 3.7% a year earlier, according to research firm LPS Applied Analytics.
In July, Congress enacted legislation designed to help borrowers who owe more than their homes are worth by allowing them to refinance into a government-backed loan, provided their mortgage company forgives part of their principal. It's not clear how many borrowers the program will help, because before reducing the principal, lenders would almost always try first to freeze or reduce borrowers' interest rate to make payments more affordable, says Tom Deutsch, deputy executive director of the American Securitization Forum, an industry group.
In contrast with the 12 million home borrowers estimated to be under water, 64 million have equity in their homes. These include 24 million households who own their homes free and clear, and 40 million whose homes remain worth more than is owed on them.
Even so, some borrowers fret that declining prices and tighter lending standards could make it hard for them to tap their equity.
Steven Schneider, a mortgage broker in Miami, bought his home at the end of 1992. When he refinanced about four years ago, he pulled out $150,000 in cash that he intended to use to build an addition. The transaction raised his total debt to about $350,000, at a time when his home had a value of about $650,000.
Recently, Mr. Schneider pulled out roughly $90,000 by tapping a home-equity line of credit. He says he put the funds in a money-market account that yields less than the 5% interest rate on the loan. "I was afraid they were going to shut down" access to the credit line, says Mr. Schneider. He figures his home, once valued at $750,000, now is worth about $600,000.
How much pain homeowners feel varies greatly from place to place. The most severe drops in home values are in parts of California, Florida, Nevada, Arizona and other areas where speculation pushed prices up and builders far overestimated demand.
Within metro areas, neighborhoods with short commutes are holding up better than others. And in many parts of Texas and North Carolina, home prices have continued to rise slowly, have leveled off or have declined only modestly.
On a national basis, home prices peaked in mid-2006 after rising 86% since January 2000, according to the First American index. Since peaking, that index has fallen 13.
The declines have made homes more affordable, bringing prices in many areas closer to their long-term relationship to incomes. In the second quarter, the median home price of about $203,000 was 1.9 times average pretax household income, according to Economy.com. That was close to 1.87 times income for 1985 through 2000, prior to the housing boom.
Housing markets don't tend to turn around quickly. The price slump in California in the early 1990s, for instance, was a long grind. According to the S&P/Case-Shiller home-price indexes, Los Angeles prices peaked in June 1990 and didn't bottom until March 1996. They didn't get back to their 1990 peak until 2000.
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