The current housing market contains a $3.7 trillion negative equity gap, says economist William Emmons. Emmons, Assistant Vice President and Economist at the Federal Reserve Bank of St. Louis, spoke at HousingWire’s Rethink Symposium last Friday, a conference centered on how housing finance affects the economy.
In his speech, Emmons cited data which shows the average loan-to-value (LTV) ratio for those with mortgage debt is around 94.3%. Loan-to-value ratio is the amount of mortgage debt in relation to the home’s appraised value. The current average LTV ratio in the U.S. is now much higher than the preferred 58.4% ratio homeowners had from 1970 to 2005.
So many homes have lost their value that LTV ratios across the country have gone up, causing this huge negative equity gap. Homeowners with high LTV ratios end up upside down –-meaning they will owe more on their homes than their homes are currently worth. Many of these homeowners are also paying high mortgage interest rates, further compounding the problem.
Emmons is concerned the federal initiatives launched to remedy the housing problem aren’t enough and in fact merely delay the inevitable, meaning more foreclosures and even lower home values.
For instance one of these programs, the revised Home Affordable Refinance Program (HARP), allows homeowners who are underwater to refinance in order to get a lower monthly payment, but it hasn’t been very successful. It won’t help homeowners whose mortgages originated before 2009 and it won’t help those facing foreclosure. Some lenders won’t even participate in the program. HARP doesn’t reduce the mortgage principal, so even after homeowners refinance under this program the homes will still be underwater.
Emmons suggests one alternative is for private owners to buy distressed properties to “recapitalize the housing sector.” Just last month the FHFA introduced a pilot program allow prequalified investors to bid on foreclosed properties and convert them into rentals. Demand for rental properties is high, especially here in the metro Boston area where we’ve seen rents increase dramatically. But Emmons says that home values would need to drop another 20% to bring enough buyers to make a difference, and then the mortgage debt would swell to $4.97 trillion.
For homeowners with negative equity short sales still offer the best solution for both the homeowner and the housing market.
In February we did a study that showed short sales are better for banks than foreclosures. The average short sale home sold for 24% more than the average foreclosed home, which means more money for the banks. Since these homes sell for more they don’t drag home values down the way foreclosed homes do.
And short sales are definitely better for homeowners than foreclosure. They allow distressed homeowners to exit their homes with dignity, they are able to buy a home again sooner, and the remaining debt from their mortgage is forgiven. Many banks are offering cash incentives for homeowners to short sale their homes. In fact over 28% of our short sale clients get money at closing for relocation assistance and we expect that number to increase in 2012.
Homeowners with negative equity are more likely to allow their homes to go into foreclosure. And as we reported last week, foreclosures are increasing as banks step up the foreclosure process and are even getting paid to reach out to borrowers as soon as they miss a mortgage payment. But banks would rather have the homeowner do a short sale since they take in more revenue from a short sale and don’t have to pay the legal fees associated with a foreclosure.