Underwater Homeowners Represent Drag on the Economy

We have discussed the plight of underwater homeowners ad nauseum on this blog over the past year or so (an underwater homeowner is one who has negative equity, who owes more on their mortgage than their home is worth).  Currently as many as a quarter of American homeowners are undewater, and as many as a quarter more have less than 10 percent equity in their homes, which could be quickly wiped out by price declines.

Borrowers who have negative equity are far more likely to default on their mortgages, either intentionally through strategic default, or unintentionally due to lack of income.  Today there is an article in the Los Angeles Times by Don Lee with a novel take on the issue of underwater homeowners: the drag on the economy that is presented by those borrowers who are underwater who continue to make their mortgage payments.  From the article:

“How could [continuing to make payments on an underwater home] be a source of future trouble?  Because, with home prices stagnant in much of the country, payments on mortgages that are underwater could absorb billions of dollars that might be used for other forms of consumer spending – a drag on family finances, the housing market and the overall economy“.

According to the article, there are about 15 million homeowners who have negative home equity, and of those, more than half owe at least 25% more than their properties were worth in the first quarter of 2010.  When you look at the numbers, you can see just how much money is being spent that is not building equity or otherwise stimulating the economy, and why negative equity acts as an anchor on the economy.

Most of these people are effectively trapped in their homes for the foreseeable future.  Most of them are able to afford their current mortgage payments and continue to do so.  There are several problems here:

• These homeowners are unable to sell their houses (without taking a massive loss or conducting a short sale that needs bank approval and will hurt the borrower’s credit).  As a result, they are unable to move in order to find new employment.
• These borrowers cannot meet the loan-to-value ratios most lenders require to refinance their mortgages.  A majority of these underwater borrowers are paying mortgage rates that are well above the national average, and are missing out on thousands of dollars worth of savings today’s record low rates would afford them.  Frequently these borrowers are also unable to qualify for many loan modification programs because they are current on their payments.
• These people are unable to move up into bigger homes, and trade-ups are absolutely vital to the housing market.  This stagnation makes it more difficult for home builders and the housing market to heal.

What we have here is a housing market that is paralyzed.  Ultimately, somebody needs to come up with some sort of solution to the negative equity that is plaguing American homeowners in order to break this logjam.  Having of millions of homeowners strategically default is not the answer, nor is the answer to have millions of people continue to throw good money after bad.  There must be some sort of middle ground that will work for borrowers and lenders alike and will allow the economy to heal.  Do you have any ideas?  Let us know in the comments section below.