Underwater Homes Hold Steady but Likely to Increase

CoreLogic's negative equity, or underwater homes, data was just about flat at the end of the second quarter of 2010 compared to the first quarter -- from 11.2 million homes underwater in the first quarter of 2010 to 11 million in the second quarter. There's another 2.4 million borrowers with less than 5 percent equity, so if home prices take a dip as foreclosures mount and homes sales plummet, the third quarter could again see an increase in the number of homes with negative equity.

Foreclosures, rather than meaningful price appreciation, drove the change in negative equity. Negative equity means that a person owes more on his mortgage than the home is worth. With nearly 28 percent of all residential mortgages in a negative equity or near-negative equity position, the potential for additional foreclosures is still great. In fact, Deutsche Bank expects that 20 million homes will be underwater by the end of 2011.

"Negative equity continues to both drive foreclosures and impede the housing market recovery. With nearly 5 million borrowers currently in severe negative equity, defaults will remain at a high level for an extended period of time," said Mark Fleming, chief economist with CoreLogic.

Even though the numbers seem high, in reality most states are not severely impacted by this negative equity trend. In fact negative equity remains concentrated in five states: Nevada, which had the highest percentage negative equity with 68 percent of all of its mortgaged properties underwater, followed by Arizona (50 percent), Florida (46 percent), Michigan (38 percent) and California (33 percent). So unless you bought at the top of the market (or refinanced at the top) in other states, you likely are not underwater on your mortgage.

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But even in the hard-hit states, the number of homes with negative equity declined. Nevada, the hardest hit state, saw an 11.8 percent decline in its negative equity share. California, Florida and Arizona saw only a 1.3 percent drop in their negative equity share. Since peaking in the fourth quarter of 2009, the number of borrowers in a negative equity position has declined by about 350,000.

Unfortunately for those underwater, the declines were not due to stabilization of the real estate marketplace or small price increases, instead the increasing number of foreclosures were the primary reason we saw a decline in homes with negative equity.

Another key impact that CoreLogic found in its trend study: Negative equity has reduced homeowners' ability to move. Add that to the fact that job growth is anemic and you've got a formula that can only mean we won't see a major improvement in negative equity for a long time.

It's too early to tell whether or not Deutsche Bank is right in its prediction for 20 million homes underwater by the end of 2011 or is too pessimistic. The future of real estate depends on the job market. Until that improves we'll likely see even more foreclosures and more downward pressure on real estate prices, which means more homes underwater.

Lita Epstein has written more than 25 books including "The 250 Questions Everyone Should Ask About Buying Foreclosures."
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