Real Estate & Mortgage Insights

One in Five Homeowners in "Underwater" Mortgages

One of the harshest realities of the current mortgage market crisis is that millions of American homeowners have seen the value of their home decline dramatically, leaving them "underwater" on their mortgages. In fact, the latest study from First American CoreLogic found that 7.63 million mortgage borrowers now owe more on their home loans than their houses are worth.

That accounts for 18 percent, or almost one in five American homeowners with negative equity. The CoreLogic report suggests that if prices continue to fall even by 5 percent, another 2.1 million mortgages will also be underwater.

Hardest Hit Areas

The study, which covered 43 states and Washington, D.C., reported that most of those with negative equity loans (64 percent) are concentrated in just seven states: Arizona, California, Florida, Georgia, Michigan, Nevada, and Ohio. Nevada led the nation in per capita underwater loans with 47.8 percent. That means roughly half of all Nevada homeowners owe more than their homes are worth! Others in the top five were Michigan with 38.6 percent, Arizona and Florida with 29.2 percent, and California with 27.4 percent.

How It Happened

During the first half of this decade, prices in a few key areas, like California, Arizona, Nevada, and Florida started to skyrocket. In order to break into the market, borrowers made use of risky home loan packages like adjustable rate mortgages, no-doc "liar loans," and zero-down payment mortgages. These borrowers had little or no equity going into their home purchases.

In other areas, like the rust belt including Michigan and Ohio, failing economies and industries pushed homeowners to tap into their existing home equity to pay bills and cover costs when breadwinners were laid off.

Then the bubble popped. Foreclosure rates went through the roof, home sales tanked, inventory piled up, and home prices plummeted. A recent S&P/Case-Shiller Home Price survey showed that on average, U.S. home prices dropped 16.6 in August 2008 from the previous year. And with some states like Nevada experiencing a whopping 30 percent decline in prices in the past year, it is easy to see how borrowers got in over their heads.

What's The Big Deal?

So millions of homeowners owe more than their homes are worth. So what?

"Being underwater leaves homeowners vulnerable to foreclosure," said Mark Fleming, CoreLogic's chief economist. "Being underwater doesn't necessarily mean that you can't pay your bills but it's a necessary condition of default."

For those who can still make their monthly payments, there is no immediate danger, unless they need to sell. Selling with negative equity is virtually impossible as it means, the seller will still owe his mortgage company money for a home he no longer owns.

Then of course, there are those who were having trouble making their payments in the first place. They can't sell and they can't refinance into better loans. As soon as their interest rates reset and they are unable to make their payments, with no equity to tap into, most borrowers end up losing their homes to foreclosure.

A number of government initiatives are aimed at reducing foreclosure rates and helping homeowners get back on top of their mortgages, but they are not able to save everyone. Moreover, with prices expected to fall between 5 and 10 percent before bottoming out next year, the country may soon face a one in four rate of homeowners swimming underwater in mortgage debt.