May 27th, 2012, by Jeff Collins
Nearly a third of U.S. mortgage borrowers, and a fourth of O.C. borrowers, have “negative equity” in their homes — that is, they owe more than their homes are worth, according to a recent Zillow report. The report said also that about 2.4 million U.S. homeowners – and about 9,200 in Orange County – owe more than double what their homes are worth.
Zillow Chief Economist Stan Humphries explains what that means. And he tells us that the U.S. is about halfway through the housing market recovery, although home price appreciation will remain weak for some time to come …
Us: Are we seeing any improvement in the number of homeowners who are “under water” on their mortgage?
The lack of change does reflect basically two countervailing forces. One, home prices have been stabilizing, which is a good thing, which normally would help the negative equity rate go down.
The other thing that affects the negative equity is foreclosure rate itself because foreclosures serve to clean out the (numbers) in negative equity. It converts a house that’s in negative equity through the foreclosure process into a home in positive equity because it’s foreclosed on, someone buys it and pays a down payment.
We probably would have seen stronger movement in the negative equity rate if we had the same rates of foreclosure liquidation that were occurring prior to the robo-signing controversy in the fall of 2010. Since that time, the pace of foreclosures has really slowed down, and people are cleaning out the negative equity rate at a slower rate than they were before.
Us: Is a stable negative equity rate good for underwater homeowners trying to hang onto their homes?
Stan: I suppose that’s true. For people who are in default, a stable negative equity rate would be good news because one of the underlying reasons for that is not processing foreclosures.
Although for the overall housing market, that does create enormous uncertainty because these are people who long term are not going to turn into performing loan (borrowers), so therefore are going to lose the house. Essentially that becomes part of the shadow inventory of homes that are not yet on the market but likely are going to be on the market in the near future.
Us: A fifth of U.S. mortgage borrowers owe at least 20% more than their homes are worth. How is that impacting the market?
Stan: Most research seems to suggest when you get to a loan-to-value ratio north of 135% (or owing 35% more than a home is worth), that’s where you start to really see strategic default behavior (where borrowers walk away from the home). It’s definitely worrisome.
(But) I think some consumers often equate the two very directly, that negative equity directly results in foreclosure. Of course, that’s far from the truth.
Our research shows nine out of 10 folks who are under water are paying the mortgage. Most of these people who are underwater are going to continue paying the mortgage.
But, that said, households that have negative equity are most vulnerable to liquidity shock, to some income disruption at the household level. So a lost job, a death, divorce, those events coupled with negative equity will make it much more likely a house will go into foreclosure. That’s the biggest risk that these negative equity homes pose to the housing market..
The second impact, of course, it creates basically a lock-in effect or a freeze within the housing stock where people are totally trapped in their homes and they, therefore, can’t go out and sell their house and buy another one.
If you think of the housing market like a conveyer belt or like a StairMaster in where a new homeowner moves onto the first rung, and then everyone moves up one. The ability of those who are already on the stair case to move up to the next rung, to the next step, is clogged up right now because of all the negative equity.
Us: Is housing market starting to turn?
Stan: Yeah. We scraped the bottom.
(But) it’s a multi-year process, where first you hit the bottom of home sales. And then you start to see these long-horizon buyers like investors, second-home buyers and retirees – buyers who tend to own the asset for a long period of time.
Then we start to see ZIP codes within metros start to recover, and then we see the bottom of home values at the metro level. And then we eventually see a bottom of those nationally.
In that sequence of events, we are at least halfway through.
We think that nationally (prices) will hit bottom later this year. Generally, I think the recovery in the housing market is well under way.
Certainly, the last several months have been pretty positive in terms of news in the housing market. Generally, we’re seeing demand about 12% above where it was last year. I think buyers are probably getting off the fence and buying homes in 2012, which is why we’re seeing this uptick in demand.
Us: When will prices go back up?
Stan: For a lot U.S. markets, the bottom has already arrived, or we’ll see the bottom arrive sometime in this calendar year, which we think is great news.
I think more importantly, at this point, consumers should get the message, part of the thing with negative equity is that they should not expect at V-shaped recovery in terms of home values. We’re certainly not going to go back to the boom-years appreciation, where it was 5% to 10% annualized. Even normal appreciation, we think, will be out of reach in the immediate aftermath of the bottom.
Normal appreciation is 2 ½% to 5% range for home values. We think appreciation will be more in the 1% to 3% range, and that’s largely factored by the negative equity picture. Nationally, we’ve had a decline in home values of about 24%, and you can’t endure a decline of that magnitude without leaving some significant scaring.
One of the chief scars that has been left negative equity, and that is going to color the markets for the next two to four years, until we can work past that … The good news there is home values aren’t falling any more.