At long last, policymakers are starting to turn their attention toward the problems caused by negative equity. Between a robosigning settlement with $17 billion for principal reductions and new Home Affordable Modification Program incentives for writing down principal, homeowners who owe more than their homes are worth may be finally getting some relief. But those two initiatives target only a small fraction of underwater homeowners, and Fannie Mae and Freddie Mac still do not allow principal to be written down on the loans they back—some 60 percent of the market. There is still more to be done to address negative equity and the effects it has on families, communities, and the housing market. Some may wonder, why does negative equity even matter? How does it affect me if my neighbor’s house is underwater? We took a look at the research on the impacts of negative equity and found that when negative equity is widespread, communities lose, too.
Homes with negative equity are more likely to go into foreclosure than are homes that have equity. Negative equity can create a cycle in which a growing number of concentrated foreclosures exacerbates the decrease in property values, which further weakens the financial condition of neighboring homeowners, which can lead to additional foreclosures. Research indicates that while it is unlikely that slightly underwater homeowners will default if they can still afford the monthly payments, homeowners with a loan-to-value (LTV) ratio exceeding 110 percent (meaning that the outstanding mortgage debt is 10 percent more than the value of the property) are more likely to default on their loans. And the farther underwater a home is, the higher the likelihood of default. One report found that homeowners with LTV ratios higher than 150 percent are seven times more likely to go into foreclosure than are homeowners with some equity in their homes.
In addition to contributing to more foreclosures, negative equity threatens the success of programs attempting to prevent foreclosures. Loan modifications that do not include a principal reduction component are more likely to go into foreclosure, or re-default, than modifications that address negative equity. One study found that underwater homeowners with subprime mortgages who received loan modifications without principal reductions are four times more likely to re-default than homeowners whose modifications include principal write down.
Even if negative equity does not result in default and foreclosure, it can reduce neighborhood wealth and stability and limit opportunities for homeowners to use home equity to finance retirement, higher education, or entrepreneurship. Underwater homeowners also encounter challenges when trying to sell their homes, since the sale is often contingent upon the loan servicer approving a short sale. Options to refinance underwater loans are often limited as well, though policymakers have recently expanded programs designed to facilitate refinancing of loans with negative equity. Additionally, research indicates that homeowners with underwater mortgages are less inclined to invest in the maintenance of their property than are other homeowners, which contributes to neighborhood destabilization.
Homeowners with negative equity may be able to better absorb the loss of assets if they also have diversified sources of wealth, such as investments or savings. Conversely, homeowners who have a large proportion of their wealth tied up in home equity may be particularly vulnerable to the effects of negative equity. The destruction of assets caused by negative home equity may disproportionately threaten the economic security of people of color because home equity is a larger proportion of their net worth than it is for whites. More than half of the net worth of Latinos and African Americans in 2009 was attributable to home equity, compared to 38 percent for whites.
It’s clear that widespread home equity hurts all of us, not just the homeowners who have experienced a loss of wealth. We applaud the policymakers who have recognized this pressing problem and will continue to work to remove remaining obstacles to addressing negative equity, such as the Federal Housing Finance Authority’s continued opposition to writedowns on Fannie and Freddie loans.