There has been a steady stream of information and media hype about the large percentage of homeowners that are underwater on their mortgages. According to CoreLogic, there are 11 million homeowners in the U.S. that owe more than their homes are worth. For many Americans, the majority of their assets are tied to their homes. Many of these homeowners have questioned why it makes sense to carry a mortgage on a house they struggle to afford, if they owe more than what it’s worth. The situation has led to short sales, foreclosures and bank renegotiations. As people have felt less secure about their financial position and retirement plans, the statistics have also impacted consumer confidence and a recovery.
The current situation for homeowners appears to be bleak indeed. Is it possible that the issue of underwater homeowners has been overblown? Consider the following: The housing bubble has led to a price overcorrection, where prices are arguably, ridiculously low. In areas that have been hardest hit by the price drop in housing, such as Florida, Arizona and Nevada, prices have already begun to rise. Henry Case, of the Case-Shiller Index, projects appreciation of 30% over the next three years, or 8-10% appreciation per year. Lawrence Yun, Chief Economist for the National Association of Realtors, projects double-digit appreciation this year in Florida. These projections are significantly higher than the typical appreciation of 5% seen annually under normal market conditions.
How will the rapid rate of appreciation impact the underwater homeowner situation? If prices increase dramatically, the appreciated value will offset any perceived loss in value that has occurred from the downward spiral in prices experienced over the last 5-7 years. For example, a homeowner that purchased a home at $500,000, who obtained a mortgage of $460,000, saw the home’s value drop by 40%. The result was a $460,000 mortgage on a home that was now worth $300,000.
The Result: An unhappy homeowner that not only lost $200,000, but also now owed $160,000 more than the house was worth. To add insult to injury, the mortgage interest rate at 6% was much higher than the rate given to purchaser today for 3.9%. Wow! Talk about a double-whammy.
Just when all appeared to be lost (based on all media reports), prices begin to increase and voila! At 20% increase in 2012, to $360,000. Another 20% in 2013, and before you know it, just like magic, the poor underwater homeowner now has a house worth $432,000 with a mortgage of $460,000. Although this example may be embellished, you get the picture. It may not take long at all for the underwater homeowner to be made whole again. It’s quite possible that the situation could resolve itself faster than the 3 year time period it takes for short-sale homeowner’s to see their credit recover.
One final note, even those homeowners who are unable to refinance at a lower rate, the next three years may bring rates higher that the 5-6% they are paying. If that happens, their rates may seem like a bargain. In conclusion, don’t believe all of the hype about how dire the situation is with underwater mortgages. It may not be a serious issues for long.