Monday, September 29, 2008

Homeowners with Negative Equity

by Bill McBride on 9/29/2008 07:09:00 PM

The following analysis is based on data from the Census Bureau (for 2007) and First American CoreLogic at the end of 2006. Although some of this data is a little old, it provides us with an estimate of the number of Americans household underwater (with negative equity).

According to the Census Bureau's 2007 American Community Survey there were 51,615,003 households with a mortgage in the U.S. at the end of 2007.

Homeowners with no or negative equity Click on chart for larger image in new window.

For prices, using Case-Shiller, by the end of 2006 U.S. home prices had fallen just over 1% from the peak, but a number of homeowners were already underwater because they bought their homes with more than 100% LTV financing.

By the end of 2007, prices had fallen 10% from the peak, and 8.2 million homeowners owed more on their mortgages than their homes were worth.

As of Q2 2008, prices had fallen almost 18% from the peak, and for the graph, I estimated that prices will decline about 22.5% from the peak by the end of 2008. (this seems conservative). This means about 15.4 million households will be underwater or already foreclosed on by the end of 2008.

The last two categories are based on various estimates for the price bottom (peak-to-trough). The 30% decline was suggested by Paul Krugman in December 2007: What it takes). The 35% decline is close to the "severe recession" case presented by JPMorgan last week.

Not every homeowner with negative equity will default, in fact many of these homeowners will only be underwater by a few percent. But if we estimate one half of homeowners with negative equity will eventually default, use a 50% loss severity, and a 35% price decline (23.6 million households with negative equity), and use the median house price from the Census Bureau of $216 thousand, we get $1.3 trillion in mortgage losses for lenders.

I think this is probably high (probably fewer than 50% will default), but this does give a general idea of the potential losses. If we use one third of homeowners, the mortgage losses with a 35% peak-to-trough price decline would be about $840 billion.

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