Over 23% of All U.S. Residential Mortgages Now Underwater in Q4; Represents $750 Billion of Negative Equity Losses

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According to CoreLogic (NYSE: CLGX), over 11.1 million (23.1%) of all U.S. residential properties with a mortgage had negative equity at the end of the fourth quarter of 2010. This is an increase from the prior 10.8 million, or 22.5 percent, in the third quarter.

The small increase reflects the price declines that occurred during the fourth quarter and led to lower values. An additional 2.4 million borrowers had less than five percent equity, referred to as near-negative equity, in the fourth quarter. Together, negative equity and near-negative equity mortgages accounted for 27.9 percent of all residential properties with a mortgage nationwide.

Negative equity, often referred to as "underwater" or "upside down," means that borrowers owe more on their mortgages than their homes are worth. Negative equity can occur because of a decline in value, an increase in mortgage debt or a combination of both.

"Negative equity holds millions of borrowers captive in their homes, unable to move or sell their properties. Until the high level of negative equity begins to recede, the housing and mortgage finance markets will remain very sluggish," said Mark Fleming, chief economist with CoreLogic.

Report Highlights

• Nevada had the highest negative equity percentage with 65 percent of all of its mortgaged properties underwater, followed by Arizona (51 percent), Florida (47 percent), Michigan (36 percent) and California (32 percent).

• At 118 percent, Nevada had the highest average loan-to-value (LTV) ratios for properties with a mortgage, followed by Arizona (95 percent), Florida (91 percent), Michigan (84 percent), and Georgia (81 percent). New York had the lowest LTV at 50 percent, followed by Hawaii (54 percent), District of Columbia (58 percent), Connecticut (60 percent), and North Dakota (60 percent).

• The distribution of LTV varies greatly by state. For example, California has a higher share of borrowers with 60 percent or less LTV compared to Texas even though California has a negative equity share that is 3 times higher than Texas. Florida and Michigan have fairly similar concentrations of low LTV loans, but above 70 percent LTV the profiles of the states begin to diverge with Florida significantly worse than Michigan.

• The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 set forth the qualified residential mortgage (QRM) designation, which exempts lenders from risk retention requirements for the loans to be securitized, making those loans cheaper to originate. While there are many aspects to the definition, an emerging consensus is that a 20 percent down payment will be one of the features. Clearly, higher down payments are necessary to reduce credit risk for lenders and securitizers, but given the majority of homebuyers are repeat buyers who use current equity as the bulk of their equity, states that have a lower proportion of borrowers with 80 percent LTV or less will be adversely affected because repeat buyers will not have sufficient down payments to buy new homes with QRMs. In the U.S., 54 percent of homeowners with mortgages would qualify for the exemption using the 20 percent definition. But more than 70 percent of borrowers in New York, Hawaii and North Dakota would qualify, so the impact in those states will be smaller than the impact on the U.S. Conversely, Nevada will be the most negatively impacted by the QRM exemption, because few homeowners have 20 percent equity or more in their home. Other hard-hit foreclosure states that would be negatively impacted include Georgia and Colorado.

• The consensus is that home prices will fall another 5 percent to 10 percent in 2011. If so, the most that negative equity will rise is another 10 percentage points, all else equal . What's important is not just the share of at-risk loans (i.e., loans with less than 10 percent equity) but current price movements. At the safe end of the spectrum, New York, North Dakota and Hawaii have very low shares of at risk loans (less than 7 percent) and prices are still increasing, so the risk is minimal (Figure 5). Colorado, Tennessee and North Carolina appear to be the riskiest because they each have the largest percent of loans at risk (16 percent or more). However, each is only experiencing moderate price declines so the impact in these states will be small to moderate. Given price declines, the largest risk to future increases in negative equity lies in Alabama, Idaho, and Oregon which have a high share of loans that are near negative equity and rapid home price depreciation.

• The aggregate level of negative equity increased to $751 billion in Q4, up from $744 billion last quarter but still below $800 billion a year ago. Over $450 billion of the aggregate negative equity dollars include borrowers who are upside down by more than 50 percent (Figure 6).

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