The need to address the issue of negative equity has finally captured the attention of people working to mitigate the effects of the foreclosure crisis. The Home Affordable Modification Program (HAMP) recently ramped up incentives for servicers to provide principal writedowns. Attorneys general, federal banking regulators, and the five largest servicers have agreed to a robosigning settlement largely focused on reducing principal for underwater homeowners. And Edward DeMarco, the Acting Director of the Federal Housing Finance Agency (FHFA), is under pressure to drop his staunch opposition to principal reductions for loans backed by Fannie Mae and Freddie Mac.
While consumer advocates welcome the acknowledgement of the detrimental impact of underwater loans on both the housing market and neighborhood wealth, policymakers and financial institutions must also recognize the fact that the burden of negative equity is not shared equally among all communities. Our research at Woodstock Institute finds that negative equity is significantly concentrated in communities of color in the Chicago region. This spatial concentration of negative equity raises concerns that communities of color will face even higher barriers to economic recovery than will predominantly white communities.
Recent Woodstock research found that borrowers in communities of color are more than twice as likely as borrowers in white communities to have negative equity. More than 40 percent of residential properties in the Chicago region’s African American and Latino communities are underwater or nearly underwater, compared to only 17 percent of properties in predominantly white communities.
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Another troubling dimension of this situation is that almost three times as many properties in communities of color are severely underwater compared to properties in white communities. Studies have shown that when a borrower’s loan-to-value ratio exceeds 110 percent, he or she is much more likely to default on the loan. The likelihood to default increases as the loan falls farther underwater. Our report found that 30 percent of properties in the Chicago region’s African American and Latino communities have loan-to-value ratios exceeding 110 percent, compared to 10 percent of properties in white communities.
Widespread negative equity exacerbates the wealth gap between homeowners in white communities and homeowners in communities of color. Only about one-third of borrowers in the Chicago region’s African American and Latino communities have equity of 25 percent or more of the value of their homes, while more than half of borrowers in white communities have equity of more than 25 percent. The average loan-to-value ratio is 92.1 in African American communities and 87.4 in Latino communities compared to 67.7 in predominantly white communities. When so many homeowners have so little equity in their homes, opportunities are limited for homeowners to use home equity to finance repairs, retirement, higher education, or entrepreneurship.
Negative equity and its destabilizing impacts—higher default rates, less property maintenance, fewer assets—are concentrated in communities of color. To get these communities on the path to recovery, policymakers and financial institutions will have to take action to seriously address negative equity and ensure resources reach neighborhoods that need them. New initiatives to promote principal reductions, such as the changes to HAMP and the robosigning settlement, are steps in the right direction. One major obstacle to making headway on negative equity remains: Edward DeMarco and his inflexible stance against principal reductions on Fannie Mae- and Freddie Mac-backed loans. We ask Mr. DeMarco to reconsider his position in light of HAMP’s new incentives for principal writedowns, the fact that principal reductions can be better for investors than foreclosure, and the destructive impact that concentrated negative equity has on our nation’s communities, particularly communities of color. If not, DeMarco should step aside and make room for a new director who would act in the interests of taxpayers, homeowners, and communities.