The number of homeowners across the country that are considered to be “underwater” lies somewhere between one-in-six and one-in-eight, according to a recent
Wall Street Journal article. The number of those who owe more on their mortgages than their homes are worth has been growing since the housing bubble burst in 2005. Most of the upside down or underwater homeowners are in mortgages where they made small or no down payments, compounding the foreclosure probability.
These underwater borrowers are considered one of the greatest threats to a housing recovery as they are only a step away from possible default and foreclosure, and therefore another brick in the wall for price declines. In an effort to stem the tides, the Feds and lenders such as
J.P. Morgan Chase and Bank of America seem dedicated to programs to help the most distressed homeowners.
However, studies of past downturns indicate that being underwater doesn’t necessarily lead homeowners to default on their mortgages. In studies economists found that homeowners typically lost their homes only after at least two things happened: they either couldn't afford the payments any longer due to a change in employment status, illness, divorce or other family dynamic, or they stopped making payments after losing hope that prices would eventually recover.
The economy’s free fall and the recent increase in job losses will likely portend higher foreclosure numbers by percent than in past downturns. One thing that is very valuable in today’s market even with falling values, is the low-interest fixed-rate loan. Holding on to that important asset is not only valuable in itself, but the downside of default carries substantial repercussions into the future.
The
WSJ lays out the future scenario for a borrower who defaults on a mortgage:
A person with a stellar credit score from the high 700s to the top score of 850 would see it drop more than 200 points. A person whose credit score is lower may see it fall by fewer points, but still end up with a score in the mid 500s. At that level, reasonably priced new debt, from credit cards to car loans, will be out of reach. In addition, a default could lead landlords and utilities to require more cash up front and even affect your job prospects.
If the borrower continues to pay other debts on time, the score will climb gradually, though it may take three to five years to return to "good" scores, from the mid-600s and up. Scores of 790 or more -- which are rewarded with the lowest interest rates -- won't be attainable for at least seven years, when the default blemish finally disappears.
Fannie Mae requires borrowers who have lost their homes to foreclosure to wait five years before it will accept a loan from them, though borrowers who had extenuating circumstances, such as an illness or job loss, may requalify within three years.
What's more, lenders in most states can go after homeowners for an unpaid balance on a mortgage. That's a real risk, especially if you have other assets.
The longer you stay in your house, the better the chances of making it through this down cycle. Though a return to peak prices may take five or 10 years, some housing markets may start to bounce back once credit becomes more available. Meanwhile, you'll be reducing your mortgage as you make your payments.
In the years around the 1991 recession, economists’ and pundits’ predictions on real estate agreed that real estate appreciation was a thing of the past and would not be seen again by future generations. Nothing could have been further from the truth.
