• Home
• Personal Finance
• Economy
• New School
• Asked & Answered

• ABOUT
• FAQ
• RESOURCES
• ADVERTISE
• CONTACT

Negative Equity is STILL a Huge Problem

Negative Equity issue hasn’t gone away and actually maybe getting worse.  If we continue to ignore this issue our economy will languish at best or double-dip into a depression at worst.  “Kicking the can down the road” is not the solution to this problem - maybe a little pain for Wall Street is.

What is Negative Equity?

Most recent data (1st quarter 2010) indicated that 11.2 MILLION properties had negative equity - that’s about 24% of all mortgages in U.S.  Media uses the term ‘underwater’ or ‘mortgage is underwater’ quite a bit.  Negative equity or underwater mortgage is when a homeowner’s owes more on mortgage(s) than what the home is worth.  For instance, you may owe $185,000 in mortgage principal but your house is worth $150,000.  There is NO equity in home and in fact if you were lucky enough to sell your home say at $150,000 you would still OWE money to lender.  Imagine that - still owing money to lender after selling home - in the above example - $35,000.  See the problem. 

How does Negative Equity effect us?

Negative equity effects us in many ways.  First, the obvious one is that it makes it extremely difficult to sell our homes.  Do you have an extra $35,000 (above example) to pay lender off?  This effect is freezing many housing markets in U.S.  Second, negative equity is a leading reason why people decide to strategically default on their mortgage - meaning walk away from home and mortgage.  After all it is a losing proposition - continuing to pay money on a property that may never regain its original (over inflated) value.  So the more people decide to strategically default means more vacant homes in a neighborhood which become eyesores or worse havens for criminal activity.  This effect has a negative impact on property values of neighboring properties and possibly making a negative equity situation even worse for neighbors. 

There is a certain snow balling effect to this negative equity problem.

How does Negative Equity effect financial sector?

Obviously the financial sector takes a hit when property is sold for less than outstanding mortgage principal but they can absorb those losses through accounting and tax schemes.  There is something else that is lurking out there in financial sector balance sheets.  In most cases, because of negative equity, high unemployment and high probability of default, the actual value of these mortgages is considerably less than their book value.  To a certain extent banks have written down the values of mortgage portfolios - but was it enough?

During the housing boom - it was very common to have a first mortgage and second mortgage.  Second mortgage was typically used because homeowner/borrower had no downpayment or downpayment was not 20% of purchase price (not enough to avoid private mortgage insurance).  It’s estimated that there is at least $1 TRILLION of second mortgages outstanding and four of U.S. top banks hold over 40% of these second mortgages.  That’s a huge amount of money. 

If a homeowner is experiencing negative equity and likely defaults what will banks do?  Foreclosure?  Sure it’s happening in large numbers but the big banks have a huge problem which is not getting enough attention (maybe it is behind close doors in DC and Wall Street).  What is the REAL value of the estimated $1 trillion in second mortgages?  Because if the property has negative equity and foreclosed on there is a good chance that first mortgage may be paid off from foreclosure sale proceeds but there may be NOTHING left to pay second mortgage. 

It is an issue of SOLVENCY - meaning are asset values on bank balances sheets more or less than liabilities.  If asset values are less than liabilities a bank is INSOLVENT.  How many of these second mortgages on the books of big banks WORTHLESS?  And if they are worthless what does that mean for the solvency of those big banks?  Inquiring minds want to know!

Good luck.