Home equity borrowing's ugly aftermath
As falling prices push homes into negative equity, past borrowing against the property digs the hole even deeper.
This post comes from Marilyn Lewis at MSN Money.
Housing analysts are learning more about why home mortgages go "underwater," when the mortgage owed is more than the home's value.
- An additional 2.5 million had only 5% equity. Researchers call that "near negative equity."
- Combined, that's nearly 28% of all properties with a mortgage in the U.S.
Borrowers who are underwater typically won't start digging out until 2015 to 2020, depending on where they live, says a study by CoreLogic for USA Today.
Falling home prices, of course, are pushing homes underwater. If your home was worth $300,000 when you took out a $250,000 mortgage but now it's worth just $225,000, you're underwater by up to $25,000.
To sell the home, you'll have to pay your bank $25,000 to retire your mortgage or, as some sellers do these days, negotiate a "short sale" with the bank to get released from the mortgage contract for less.
Equity borrowing digs the hole deeper
They found that "borrower equity extraction also significantly increased the risk of a negative equity position." Translation: If falling prices push homes into negative equity, borrowing against the home digs the hole deeper.
Here's how: Say you bought a home six years ago for $400,000. You took out a $250,000 mortgage, contributing $150,000 out of your pocket from the sale of your previous home. You had $150,00 in equity when you purchased, and today, with your home's value having fallen to $300,000, your equity has shrunk to $50,000. Still, you're not in negative equity.
But if you've been nibbling away at your equity by borrowing against it -- say you've run up $63,000 on a home equity line of credit -- your borrowing has pushed your home underwater.
You're not alone: Of everyone underwater on a mortgage, more than 40% -- 4.5 million -- have home equity loans, says CoreLogic.
People with home equity loans are "significantly" more likely to be underwater, say the researchers: 18% of borrowers with no home equity loans were underwater, compared with 38% who borrowed on equity. Post continues after video.
The consequences are surprisingly many. If you're negotiating a short sale with your mortgage lender, for example, it's more difficult with an equity loan attached to the house. That's because banks holding second loans must agree to take a loss, something they're reluctant to do, says The Wall Street Journal in this article about equity borrowing.
When a homeowner's house is underwater, "it's harder to get a credit card or a car loan, you can't put your home up for a small business loan," said Mark Zandi, chief economist at Moody's Analytics.
The Journal continues:
Second mortgages have made it more difficult for troubled borrowers to negotiate loan modifications with lenders. Economists say borrowers with second mortgages on homes that are underwater are far more likely to walk away from their homes.
And among reader comments about the Journal article, reader "Gary Ray" points out:
You can often walk away from your first mortgage (no recourse) thanks to the Mortgage Forgiveness Debt Relief Act. …
However, the second mortgage, or HELOC is a different story. If it's discharged, it gets reported as income to the IRS and you owe taxes on it (1099-C). That's going to sink most homeowners, and the only way around it is to declare bankruptcy, which is far more difficult, costly, damaging to credit and psychologically daunting than just "walking away."
The bigger the loan . . .
According to CoreLogic research, the more loans attached to a property, the deeper underwater the mortgage is:
- People with positive equity have an average 1.2 loans per property.
- People with negative home equity have an average 1.6 loans per property.
As you'd expect, the bigger the home equity loan, the deeper the home is likely to be submerged:
- The average negative-equity borrowers without an equity loan "is upside down by an average of $52,000."
- On average, negative equity borrowers with home equity loans are $83,000 underwater.
The home equity loans account for 10% of the U.S. mortgage market, according to The Journal's coverage:
It's not clear how much cash withdrawn from homes during the boom was used to acquire luxuries such as expensive automobiles, and how much went to basic necessities, including tuition expenses, or renovations intended to raise a property's value.
There are lessons here, even if we're late in getting to them. Ezra Klein, who takes apart the economics of political issues at The Washington Post, says (in this article about Gov. Rick Perry) that Texas "benefited from stringent regulations that limited home-equity lending and restricted 'cash-out' refinancing -- a common practice in hard-hit states like Florida and California."
The restriction protected Texans when the housing bubble burst: "Only 6% of Texas borrowers were in or near foreclosure, versus a national average of nearly 10%."
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