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Drowning In Debt - 25 Million Will Be Underwater With Their Mortgages By 2011

The clock is ticking. Homeowners are drowning. And the water is only getting deeper.

That's the vision of Deutsche Bank, which this week released a disturbing study that predicts 48 percent of all homeowners with mortgages will be underwater by 2011 - that means, their homes will be worth less than their mortgage balance.

Home equity? It could be decades before some of these homeowners see even a penny of home equity.

In "Drowning in Debt - A Look at 'Underwater' Homeowners", Deutsche Bank researchers Karen Weaver and Ying Shen concluded that in at the end of the Q12009, "14 million U.S. homeowners had negative equity, or approximately 27 percent of all homeowners with mortgages."

In June, Weaver, Shen and their colleague Katie Reeves published a study concluding that home prices wouldn't stabilize until the end of Q1 2011. Applying their home price projections to the current number of households with mortgages, they figured that approximately 48 percent of all homeowners with mortgages "will have negative equity before home prices stabilize."

In some communities, notably Las Vegas, Florida, and Phoenix, Weaver and Shen predict 90 percent of homeowners will be underwater with their mortgages.

Drowning in debt, indeed.

The problem stems from a perfect storm of easy credit and rising home values. Homeowners, feeling enriched by home prices increases they could watched rise on a monthly basis, extracted 25 to 30 percent of every dollar of increase in home equity.

Weaver and Shen say we used the money for "consumption." But that's just what economists call the good stuff:

  • Designer handbags
  • Vacations at 5-star resorts
  • Fully-loaded $30,000 SUVs and $80,000 Hummers
  • $300 Saturday night dates at expensive restaurants
  • The over-upgrading of our now underwater digs, including pizza ovens, $400,000 spa pools with fountains, waterfalls and underwater music, granite and marble on every surface, bathrooms for every bedroom (and then some), garages with car wash systems, basements with full-size basketball courts, flat-screen televisions in every room of the house.
It was all too easy to grab a $30,000 home equity line of credit at your local bank and spend, spend spend.

Not all mortgage products will go underwater at the same speed. About 77 percent of homeowners who took out the now-notorious Option ARMs (adjustable rate mortgages that started with an introductory rate as low as 1 percent that allowed the mortgage balance to grow 110 percent of the amount you borrowed before converting into a 1-year ARM that was fully-amortized with principal and interest) were underwater at the end of Q1 2009. The authors expect 89 percent of those with Option ARMs will be underwater by Q1 2011.

But even homeowners with conforming 30-year fixed rate mortgages are in trouble. An estimated 16 percent of them were underwater in March while 41 percent will be underwater in March 2011.

Weaver and Shen expect 47 percent of jumbo mortgage holders will be underwater by 2011, and half of those will have what they call "severe" negative equity of greater than 125 percent - their loans will be at least 125 percent more than the house is worth.

It won't be that bad everywhere. Plenty of markets will see some improvement from the huge home price declines in the current real estate cycle.

The real problem is this - in a healthy market, home prices tend to grow at just about the rate of inflation. At 3 percent per year (if you even get that much), millions of homeowners will be drowning in debt for a decade or longer.

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