HOW LONG WILL NEGATIVE EQUITY LAST?
* First American CoreLogic estimates that the typical U.S. homeowner who is in a negative equity position will not experience positive equity until late 2015 to early 2016.
* In some depressed markets, the typical borrower in negative equity may not experience positive equity until 2020 or later.
* For the foreseeable future, decline in negative equity is driven slightly more by amortization than by home price appreciation trends.
The decline in home prices and the rise in negative equity have been well documented. First American CoreLogic research indicates that more than 11.3 million, or 24 percent, of all residential properties with mortgages, had negative equity at the end of the fourth quarter of 2009. A borrower is in negative equity if he or she owes more on the mortgage than the home is worth. Given that the largest home price declines have already occurred and negative equity is not expected to continue to increase significantly, the question going forward is: “how long will these borrowers will remain underwater?” To answer that question, future home values and unpaid principal balances were projected for a selected set of Core Based Statistical Areas (CBSAs) to gauge how long it will take for the average underwater borrower to return to positive equity.
Figure 1 below projects the amount of negative equity using First American CoreLogic short-term forecasts and a baseline view of long-term price trends nationally through 2020. It also takes into account the amortization assumptions described below for ten markets. For the typical underwater borrower in the U.S. it will take until late 2015 or early 2016 for negative equity to disappear. In certain markets, it will take another five to 10 years or even longer to return to positive equity. For example, Detroit is not projected to recover even by 2020, because of its depressed economy. In markets with low shares of negative equity, the recovery time will still be long because the few borrowers that are upside down are deeply in negative equity and these are typically not high appreciation markets. Although house price appreciation will, over time, offset negative equity, amortization (the paying down of loan balances) will in most cases be a more significant remedy to negative equity. Over the next 10 years, the average loan balance will decrease by an annual rate of 3.3%; meanwhile home price are expected to increase at a 3% annual rate over the next decade.
Of the ten markets studied, the Washington-Arlington-Alexandria CBSA is expected to reach positive equity by 2015; Atlanta-Sandy Springs-Marietta, Dallas-Plano-Irving and Riverside-San Bernardino-Ontario are projected for 2016; Boston-Quincy by 2017; and Cape Coral-Fort Myers, Pittsburgh, Las Vegas-Paradise and Lancaster, PA by 2020. It is estimated that Detroit will not reach positive equity until after 2020.
Alternative scenarios – using higher and lower long-term price appreciations and alternative speeds for the recovery in home prices to the long-term average – were also considered. Assuming a 5% nominal price appreciation nationally (which would be much higher than historical appreciation, given today’s low inflation environment), the early markets will approach positive equity by 2013 and the majority will be positive equity by 2017. Assuming 1.5% nominal price appreciation, which would be fairly low relative to history, the earliest markets will not reach positive equity until 2017. When alternative scenarios of how long it takes home prices to revert to the long-term average were tested, they had a moderate impact, but not as large as the absolute level of home price appreciation or amortization assumptions.
Analysis and Methodology
A geographically diverse group of metropolitan CBSAs was selected and a forecast of home prices using the First American CoreLogic repeat sales home price index (HPI) was produced. The short-term forecasted home prices are driven by supply/demand factors such as interest rate-induced affordability, the unemployment rate, price-to-rent ratios, month’s supply and foreclosure activity. The long-term home price forecast utilizes a mean reversion-based approach on over 30 years of data for the national market which is then is adjusted for each market based on the long-term relationship between the CBSA and national price trends. In the analysis, a 3% nominal annual national long-term price projection was used given that home prices in the selected CBSAs exceeded inflation by 1% over the last 30 years and the consensus inflation forecast is about 2.0%. In addition, historical trends in the largest state-level house price busts were utilized to determine how quickly previous home price recoveries ensued and reverted back to the long-term trend. We then applied the forecast for each market to the average value for all negative equity properties to produce a forecast of future values. The same analysis was applied to a typical underwater borrower nationally.
To forecast future unpaid principal balances, an amortization schedule for a typical five-year-old loan with a fixed-rate mortgage of 6% was used. This is the typical loan in the First American CoreLogic LoanPerformance database of over 40 million active loans nationwide. Many of the markets that are most upside down in Nevada, Arizona, California and Florida heavily used alternative adjustable mortgage structures, but given the wide variety of the structures and payment options, it is difficult to determine what their amortization schedules are. However, the majority of payment option ARMs’ (among the most popular “affordability” products) interest-only period ended within five years of origination and many of these loans have already, or soon will, become fully amortizing at a faster pace than a typical 30-year fixed-rate mortgage because the principal must be paid over the remaining period of the original 30-year term.