Nearly 1 in 6 homeowners 'underwater'

By The Wall Street Journal

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 "underwater" 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.

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And having more homeowners underwater is likely to mean more eventual foreclosures, because it is hard for a borrower in financial trouble to refinance or sell a home and pay off the mortgage if the 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% of homeowners 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 underwater in this period than (at) anytime in our history."

Among people who bought within the past five years, it's worse, with 29% underwater on their mortgages, according to an estimate by real-estate Web site Zillow.com.

Most 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.

Most mortgages in default were issued in 2006 and 2007, when lending standards were loosest and the housing market was peaking. Many people 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 have 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.

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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 underwater, 64 million have equity in their homes. This group includes 24 million households that own their homes free and clear and 40 million whose homes remain worth more than is owed on them.

Nationally, 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 of 2008, 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, before the housing boom.

Housing markets tend not 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 hit bottom until March 1996. They didn't get back to their 1990 peak until 2000.

Home economics

Metro area	Price index at lowest since	Price drop since peak	Percentage of purchasers in last 5 years who are underwater	Price change needed to restore historical affordability*
New York	August 2005	8.2%	14.2%	-18.2%
Atlanta	April 2005	6.9%	19.5%	-0.5%
Miami	February 2005	26.9%	44.6%	-37.7%
Phoenix	June 2005	28.9%	40.1%	-16.9%
Washington	December 2004	18.6%	33.8%	-26.6%
San Francisco	August 2004	14.5%	36.8%	-3.9%
Los Angeles	April 2004	31.3%	39.9%	-15.0%
Las Vegas	March 2004	31.5%	56.0%	-15.4%
Boston	September 2003	14.8%	13.4%	-9.0%
San Diego	June 2003	32.4%	51.4%	-13.3%

Sources: First American Core Logic; Zillow.com; Moody's Economy.com. *= price change needed to return to average ratio of home prices to average incomes for 1985-2000.

This article was reported and written by James R. Hagerty and Ruth Simon for The Wall Street Journal.