About 40% of homeowners who took out home equity loans to extract cash
from their residences for everything from vacations to medical bills -- are underwater on their loans. This is more than twice the rate of
owners who didn't take out such loans.
It's unknown just how much cash withdrawn from homes during the boom was used to acquire luxuries such as expensive automobiles, and how much went to basic necessities, including tuition expenses, or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.
What is clear is that home-equity loans, which account for about 10% of the U.S. mortgage market, have been a headache for homeowners and lenders alike. Second mortgages refer to any loan taken out on a property that is subordinate to the first mortgage, and include home-equity loans or lines of credit.
Second mortgages are particualarly one of the weak spots in the recovery. The S&P/Case-Shiller National Index last week showed that home prices tumbled 4.2% nationwide in the first quarter, its third straight quarter of price declines after a modest recovery in early 2010. Nationwide, prices have fallen 34% since their peak in 2006. The inventory of unsold homes will take 9.2 months to sell, the National Association of Realtors said recently, about 50% higher than what is considered a healthy level.
If a 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. There are all sorts of ramifications that you don't necessarily think about.
Homeowners seeking a "short sale," in which they sell their property for less than the value of the outstanding mortgage, have a much harder time doing so when they have a second loan, because all the lenders involved must agree to take losses on the sale, and second-lien holders take the first losses in such a situation.
A study peformed by CoreLogic found that borrowers with second mortgages had deeper levels of negative equity -- an average of $83,000 compared with $52,000 -- than borrowers without second mortgages. In many cases, borrowers withdrew cash from their properties using home-equity loans or lines of credit, a type of second mortgage. The CoreLogic report doesn't include cash-out refinancing, a common practice during the boom, where borrowers opted to extract cash while refinancing their first mortgage.
Easy access to home equity loans during the housing boom put borrowers who extracted home equity at more risk. When the house prices drop the
fallout can be startling and can even put them underwater. Overall, the CoreLogic report found that the percentage of underwater homeowners declined slightly in the first quarter. About 10.9 million Americans who borrowed to buy their homes, or 22.7% of all homeowners with a mortgage nationwide, were underwater in the first quarter, down from 11.1 million, or 23.1%, in the fourth quarter of 2010.
The implication is that there are still a lot of people who are at risk of default, so delinquency and default rates are going to reflect that large amount of negative equity for some time to come. The risks extend beyond the borrowers to banks. While the majority of first mortgages were bundled into pools and resold to investors as securities, second-lien mortgages are heavily concentrated on bank balance sheets.
Nearly three-quarters of roughly $950 billion in home-equity loans outstanding were held by commercial banks at the end of last year, according to Federal Reserve data. More than 40% of that debt is on the books of the nation's four largest banks: Wells Fargo & Co., Bank of America Corp., J.P. Morgan Chase & Co., and Citigroup Inc. Requiring big writedowns on those loans could burn through banks' capital.
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.
Sheila McKinney
