Underwater Mortgages in the Eighth District

The nationwide decline in house prices during the financial crisis left many borrowers owing more on their homes than they are worth—a situation commonly described as one in which borrowers are “underwater” on their mortgage or have “negative equity” in their home. In the second quarter of 2012, 22.3 percent of U.S. borrowers were underwater on their mortgages according to CoreLogic, a leading provider of housing and mortgage data. In Nevada alone, where house prices declined by more than 60 percent from their peak, almost 60 percent of homeowners were underwater on their mortgages. Since negative equity impacts a borrower’s ability to sell or refinance a home, it can have a significant drag on the pace of the housing recovery in markets across the United States.

In addition to the large share of borrowers already underwater in the U.S., another 4.7 percent had less than 5 percent equity in their homes, which CoreLogic refers to as having “near-negative equity.” This means that approximately 13 million people, or 27 percent of all homeowners with a mortgage, are unable to sell their homes without either first putting up cash to pay off the remaining balance on their mortgage and closing costs or negotiating a short sale (in which the lender agrees to allow the borrower to sell the home for less than the original purchase price).

Refinance Options for Underwater Borrowers

In a traditional refinance, especially in today’s tighter lending market, mortgage lenders require borrowers to have equity in their home. For this reason, underwater borrowers are not able to conduct a traditional refinance of their mortgages. To help borrowers who are current on their mortgage take advantage of today’s record low interest rates, in April 2009 the government launched the Home Affordable Refinance Program (HARP). This program has subsequently undergone various changes, the more notable of which were made in late 2011 and are often referred to as HARP 2.0. They included:

1. extending the program expiration date to December 2013,
2. removing the 125 percent loan-to-value cap,
3. eliminating certain risk-based fees for borrowers who refinance into shorter-term mortgages and lowering fees for other borrowers, and
4. relaxing certain representation and warranty requirements, which reduces the risk of pre-existing underwriting deficiencies for the originator of the new HARP loan.

These changes to the HARP program appear to have boosted utilization of the program. In the first half of 2012, HARP 2.0 refinances accounted for 33 percent of all refinances, the highest percentage reported since the inception of HARP. In total, 1.4 million borrowers have refinanced under HARP through June 2012. There are limitations to the program, however. Specifically, only mortgages that are guaranteed by Fannie Mae or Freddie Mac are eligible to refinance through the HARP program. In addition, they must have been sold to one of the government-sponsored enterprises (GSEs) prior to June 1, 2009, and they cannot have been previously refinanced under the program.

Eighth District States

In the Eighth District, the impact of negative equity has not been as prevalent as it has been in other parts of the U.S. In general, negative equity is more prevalent in states where the drop in house prices was larger—such as in California and Florida, where house prices dropped around 50 percent from the peak. As shown in Table 1, the decline in house prices from their peak is lower in six of the seven states in the Federal Reserve’s Eighth District than in the nation as a whole. Only in Illinois did house prices fall more than in the nation overall—30.3 percent versus 23 percent.

Not surprisingly, Illinois is also the Eighth District state with the highest share of underwater mortgages, at 25.8 percent. (See Figure 1.) Mississippi’s rate is also higher than the nation’s, at 26.5 percent, followed by Tennessee (16.8 percent), Missouri (15.6 percent) and Arkansas (11.6 percent). The lowest negative-equity shares in the District are those of Indiana and Kentucky (both at 9.5 percent).

As in the nation as a whole, states in the Eighth District also experienced the surge in HARP modifications in the first half of 2012. Table 2 shows the share of HARP refinances for two periods—since the program’s inception in April 2009 and in the first half of 2012.

Conclusion

Despite some recent good news on house price increases in some U.S. markets, negative equity remains a significant problem. Although states in the Eighth District have generally not experienced the housing market challenges seen in other areas of the country, a significant number of borrowers are underwater, often unable to sell or refinance their homes, and therefore at a higher risk of default. Although modifications to the HARP program appear to have increased participation in this program, only government-backed loans originated in a specific timeframe qualify. Even for those who qualify, the extent to which the program ultimately helps borrowers regain and maintain their financial footing is yet to be seen.

For information about the current state of the housing market in the U.S. and the states included in the Federal Reserve’s Eighth District, please visit www.stlouisfed.org/community_development/HMC/.