Negative Equity? You Can Still Save Your Home

You wouldn’t know it from the national media, but just because your home loan is underwater meaning you owe more than the house is worth that doesn’t mean you’re headed toward foreclosure. In fact, it may not even be a remote possibility. Here are some interesting facts that indicate “underwater” doesn’t usually equal “foreclosure.”

First, some background. According to data from First American CoreLogic, about 15.2 million U.S. mortgages, or 32.2% of all mortgaged properties, were in a “negative equity” position in June 2009. More pessimistically, the expected percentage of “underwater” loans may rise to 48% or 25 million homes according to a study released by Deutsche Bank earlier this year.

Make no mistake, "owning" a home with a value that doesn’t meet your debt obligation is a stressful experience. And there’s no getting around the fact that homeowners with homes that are underwater are in greater jeopardy of falling into foreclosure than any other class of homeowner. That said, being underwater doesn’t guarantee a foreclosure death sentence.

Says who? Says a new study from the Boston Federal Reserve Bank. The study’s authors, Christopher L. Foote, Kristopher Gerardi and Paul S. Willen of the Boston Federal Reserve Bank examined roughly 100,300 homeowners whose mortgages were deemed underwater in Massachusetts in the last housing bubble in 1991.

Back then, Massachusetts was in the grip of a nasty recession, marked by a collapsing real estate market. The study’s authors say that between 1988 and 1993, home prices in the Bay State fell by more than 22%. Meanwhile, foreclosures rose accordingly, and didn’t fall back to 1990 levels until 1999.

Despite the falling home values, and the rising foreclosure rates, the study found that only a small portion of the 100,000 actually lost their houses, despite having negative equity in their home.

This, directly from the Boston Fed Reserve Study:

"Millions of Americans have negative housing equity, meaning that the outstanding balance on their mortgage exceeds their home’s current market value. Our data show that the overwhelming majority of these households will not lose their homes. Our finding is consistent with historical evidence: we examine more than 100,000 homeowners in Massachusetts who had negative equity during the early 1990s and find that fewer than 10 percent of these owners eventually lost their home to foreclosure. This result is also, contrary to popular belief, completely consistent with economic theory, which predicts that from the borrower’s perspective, negative equity is a necessary but not a sufficient condition for foreclosure."

On the surface, the Boston Fed study wouldn’t seem to add up. After all, homeowners have recently been inundated with articles, blogs, books and news segments claiming that underwater mortgages were a direct link make that a direct step to home foreclosure.

But common sense says wait a minute. As the Boston Fed study shows, if a homeowner can afford to make the monthly payments and the vast majority of mortgage holders are in that class, the study says then that homeowner is significantly more likely to keep making the mortgage payment in hopes that the economy will turn around and home values will rise once again. Meanwhile, homeowners will stay put, reluctant to part with friends, good neighborhoods, decent schools and a home in which they’ve invested so much time and energy.

In other words, the emotional attachment outweighs the financial one.

As the study concludes, “borrowers with negative equity that have ample liquid wealth will usually find it in their economic interest to stay in their homes.”

It’s an interesting study read the entire paper here.

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