MainStreet Explains: Underwater Mortgages

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It is sink or swim in today’s economy.

That sentiment resonates stronger with the millions Americans who owe more on their home mortgages than that home is worth. In other words holders of mortgages that are "underwater."

But in terms of home value, what exactly does the term "underwater" mean?

“Underwater” refers to a “case where the debt load [for a home] is higher than the asset that covers it,” says Lawrence Yun, the National Association of Realtor’s (NAR) chief economist. Technically, a homeowner finds themselves in this position when they have negative equity. Specifically, it is when the value of the home is less than the outstanding mortgage amount.

According to Moody’s Economy.com, there are about 75.5 million homeowners in the U.S. and some 12 million, or 16%, of them are now underwater. That percentage translates to roughly one in six homeowners.

Which states are in the most trouble?
The states most affected are California, Arizona, Nevada and Florida, says Yun. “The rest of the country saw prices decline, too, but not as drastically.” The Wall Street Journal reported earlier this month that 39.9% of people who bought a home in Los Angeles in the past five years are now underwater. According to a recent report released by First American CoreLogic, a business database service, however, Nevada takes the lead. The report states that 47.8% of Nevada's 609,577 mortgages are underwater; followed by Michigan at 38.6% and Arizona at 29.2%.

“Many of those homes were owned by investors who thought they’d be able to flip these homes and make a profit,” says Dwan Bent-Twyford, co-author of How to Sell a House When It’s Worth Less Than the Mortgage: Options for “Underwater” Homeowners and Investors, which is scheduled to be published February. In terms of states where most underwater mortgages are on primary residences, Twyford says, two that were heavily hit include Ohio and Michigan, which currently hold underwater mortgages at 22% and 38.6%, respectively, according to First American CoreLogic.

“All of this is the fallout from risky loans that were pushed on the market and never should have been there,” says Walter Molony, senior public affairs associate with the National Association of Realtors. Other troubled states, he adds, include Rhode Island, Kansas, Minnesota, Missouri and New York’s Long Island.


How to get out of the situation?

If you’re looking to be rescued from an underwater mortgage, the first thing to do is to call a lender and rework the loan. “Many lenders will be willing to rework the loan,” says Yun. “Some will [hone in] on details and there will be a lot of headache involved, but it should be done.”

The next step is to contact the Federal Housing Administration (FHA) originators, experts agree. Those who find themselves underwater should consider “getting out of their current mortgage and moving into a government backed FHA mortgage,” says Lyun. “There has been a surge in FHA market participation, and it’s been ongoing for the past twelve months.” The shift has been seen in those who originally took on subprime loans, largely due to market changes, he adds.

Homeowners must be aware of their options to avoid foreclosure. “Everyone is in trouble because of the adjustable rates,” says Twyford, but foreclosure doesn’t have to be inevitable. "Homeowners should look into options like loan modification and refinancing their homes."

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