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Negative Equity

Another informative article from google Real Estate.  This article can be read in full at Negative Equity.
 

Negative Equity

Negative Equity is when the value of a property used to secure a loan is less than the outstanding balance on the loan.  In real estate, the term Negative Equity is synonymous with the being “underwater” or “upside-down” on a mortgage.  In today’s real estate market, many homeowners now have Negative Equity on their home, and this has contributed to the myriad of Mortgage Delinquencies

Negative Equity: Economic Impact

During the US real estate boom, Negative Equity was not an issue.  Positive Equity (or just plain Equity) was literally built overnight, and this had a strong “wealth effect” with the US public.  Homeowners began to tap the equity that was built in their homes, and these homeowners began to spend this money on home improvement, cars, business investments, etc.  This, along with a ”full employment” rate, contributed to a strong economic environment, which was conducive to the robust economic growth that the US experienced during that period. 

Negative Equity has a negative wealth effect.  Just as positive equity contributed to US economic growth during the real estate boom, Negative Equity and the negative wealth effect are contributing to current US economic trouble.  In order to get a better understanding of which states’ homeowners have the largest amounts of Negative Equity, refer to the chart below: 

The below data and graphs used to display the US Negative Equity are from CoreLogicgoogle Real Estate:

Negative Equity

As you can see from the graph above, the states that tend to have the highest priced real estate also have the largest amounts of homeowner Negative Equity.  This makes sense, as the percentage decline in real estate prices affects higher priced property with larger, absolute amounts of Negative Equity. 

Negative Equity Distribution

Looking at Negative Equity in absolute dollars is one way of analyzing Negative Equity in the US.  Another, more informative way to gage Negative Equity is to examine it as a percentage of the property value.  Below is a graph that looks that Negative Equity in terms of percentage:

Negative Equity 1

Negative Equity 2

As seen above, the average Negative Equity for a homeowner in Nevada is almost 50%.  That is staggering and certainly must affect the homeowner’s psychology.  The Negative Equity and negative wealth effect cannot be denied and will continue to contribute to the US real estate market’s current and future Shadow Inventory levels.  This, along with the currently dismal US unemployment numbers, is one of the main reasons why the real estate market will take years to recover. 

Negative Equity and Default Rates

A homeowner that has a large amount of Negative Equity on his or her property must be disenfranchized.  If a homeowner is ”underwater” on his or her mortgage to the tune of 50%, it is understandable that the homeowner would consider defaulting on his loan or getting out of the mortgage in one way, shape, or form (either through voluntary/involuntary Foreclosure, short sale, auction, sale, etc.).  Below is another graph from CoreLogic that analyzes default rates relative to Negative Equity (through a Loan to Value ratio):

Negative Equity 3

Logically, the higher the Negative Equity, the higher the chance of a default. 

Negative Equity: Conclusion

US Homeowner Negative Equity rates are overwhelming.  If home prices continue their decline, these already alarming US Negative Equity rates will worsen drastically.  As analyzed above, the higher theNegative Equity, the higher the chance of a default.  This scenario does not bode well for the US real estate market.

Homeowners that have large amounts of Negative Equity on their home are faced with one of two decisions:

  1. Stick it out, continue making payments, and home that their home increases in value
  2. Default on the mortgage in one way, shape, or form

Both choices for homeowners that have Negative Equity do not bode well for the US economy or the US real estate market.