In the fourth quarter of 2010, 23.1 percent of homeowners with a mortgage owed more on their loan than the current value of the home, a situation that's typically referred to as having negative equity or being underwater. That's slightly higher than a quarter earlier. Add in homeowners who currently have just 5 percent equity, and the percentage of at-risk homeowners is nearly 28 percent. Not exactly the direction we're all hoping for.
It's not just the 11 million homeowners in negative equity territory who are impacted. If you happen to live in an area with a preponderance of negative equity mortgages, normal sales activity takes a hit as potential trade-up buyers can feel shackled in their current mortgage. Moreover, negative equity can be a harbinger of more foreclosure pressure, as homeowners with negative equity have more incentive to walk away from a mortgage.
Negative Equity: The Best and Worst States
According to CoreLogic, the country currently has an aggregate of $751 billion worth of negative equity. The somewhat good news is that's down from $800 billion a year ago, though foreclosures are part of the reason for the drop. It also provides some sobering perspective to the news that all 50 state attorneys general are on the verge of a foreclosure settlement with the major banks that could generate as much as $20 billion in fines. That money would then be used to modify problem mortgages. Though $20 billion would surely be a help to many homeowners, it's not much of a dent in a $751 billion problem. That said, the AG settlement would be three times larger than what the the U.S. Treasury has so far committed to its Hardest Hit Fund, in which 18 states and the District of Columbia are receiving federal funds to help with mortgage modification initiatives.
The states below have the highest and lowest concentration of negative equity mortgages. An important caveat is that this only pertains to the sub-universe of homeowners with an outstanding mortgage; people who have already paid off their mortgage are not reflected in the data.
HIGHEST NEGATIVE EQUITY STATES
- Nevada: 68 percent of all mortgages are underwater
- Arizona: 50 percent
- Florida: 46 percent
- Michigan: 38 percent
- California: 33 percent
LOWEST NEGATIVE EQUITY STATES
- Oklahoma 5.8 percent
- New York 7.1 percent
- Pennsylvania: 7.3 percent
- North Dakota 7.4 percent
- Montana 7.7 percent
Another telling way to look at a state's housing prospects is to focus on the average loan-to-value ratio. Homeowners with a lower LTV are in a better position to make a move, as they have ample equity to sell at a gain and qualify for a new mortgage. In the CoreLogic chart below, focus on the navy blue. The more navy blue the better; that's the percentage of mortgages in a given state where the LTV is less than 80 percent, meaning homeowners have at least 20 percent equity.
The healthiest housing markets as measured by low LTV are on the far left: at least 70 percent of the homeowners with mortgages in New York, Hawaii, North Dakota, Pennsylvania, and Montana have at least 20 percent equity.
Recovery Wild Card: 20 Percent Equity Threshold
Big equity stakes are likely to become a large factor in the housing market in the coming years. A piece of the Dodd-Frank financial reform bill will soon require banks to hold on to a piece of certain mortgages they originate, rather than being able to sell-off (securitize) 100 percent of the loan. The question being hotly debated in Washington right now is at what LTV level would it still be OK for lenders to continue to securitize 100 percent of a loan. Some key regulators (FDIC, the Federal Reserve, and the Office of the Comptroller of the Currency) are angling for an 80 percent LTV as the line in the sand. So if banks make loans with at least 20 percent equity, they would be allowed to securitize all of the loan if they so choose. (And to be clear: they will choose just that.) If the borrower's equity stake is below 20 percent, the lender would be required to hold onto at least some of the loan; that is, keep some skin in the game. As Warren Buffett recently pointed out in Berkshire Hathaway's annual report, when you know you are going to be on the hook -- if even for just a portion of a loan -- it makes you care about the quality of the loan a bit more.
An anticipated outcome of the new rule is that large banks with a strong appetite for securitization will prefer to make loans that meet the 20 percent equity threshold, so they don't have to keep any skin in the game. If that is how it plays out, the recovery could be an even slower slog as anyone who wants to buy a house or trade-up will need to come to the closing table with at least 20 percent down. According to CoreLogic, just 54 percent of current homeowners with mortgages have at least 20 percent equity.