Underwater Mortgages Fewer

Falling home prices could drive more homeowners into a negative equity situation where their home was worth less than the amount of their mortgage (also known as the house being ‘under water’ or ‘upside down’). If a homeowner falls further into negative equity, it increases the chances that they will walk away from their mortgage obligation. This is known in the industry as a strategic default. This could dramatically increase the number of foreclosures coming to market and cause house values to fall further.

The Wall Street Journal reported on the impact of negative equity on strategic default:

Most defaults are typically driven by a combination of income shock and negative equity, or what’s known as the “double-trigger” hypothesis. While borrowers who lose their jobs but have equity in their homes can sell and avoid default, those without any equity are left with fewer options.

The most recent Fannie Mae National Housing Survey looked at how people viewed walking away from their mortgage obligation. Here are some of their findings:

  • Underwater delinquent borrowers are the most likely to have considered stopping their mortgage payments.
  • Delinquent borrowers are almost three times as likely to have considered stopping their mortgage payments if they know someone who has defaulted on their mortgage.
  • 17% of all people who are delinquent believe the amount they owe on their mortgage is 5-20% more than the value of their home. That number jumps to 29% when they believe the amount they owe on their mortgage is at least 20% more than the value of their home.

The End Results

If people fall into negative equity, the chances they will strategically default increases. This would lead to more foreclosures which will mean more downward pressure on home values. More homeowners will see themselves in negative equity as prices fall. And round and round we would go. Let’s hope prices hold thus preventing this from happening.

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