The US market is drowning in underwater mortgages

There was an interesting report that lobbed this week that you may have missed in what has been a bumper week in business news. 

Real-estate information site Zillow released a report which showed that almost one in five mortgages in the US are currently considered ‘underwater’.  What that essentially boils down to is that people owe more on their home than what it is worth.

Overall, 18.8 per cent of US homeowners with a mortgage, or 9.7 million homes, fell into this category in the first quarter of 2014.

While that figure is down from 19.4 per cent at the end of 2013 and well off highs of 31.4 per cent in 2012, it is having a knock-on effect that is impeding those brave souls that actually want to get into the housing market for the first time.

That is because on top of the 9.7m US mortgages that are underwater, a further 10m have less than 20 per cent equity in their homes. That means they can’t afford the costs associated with selling a home, such as broker fees, closing costs, or a downpayment on a new place.

US Census statistics released last week show the level of home ownership for those under 35 has fallen much faster than the average. It slipped to 36.2 per cent in the first quarter, from 36.8 per cent in the fourth, and falling further away from its peak of 43.6 per cent in 2004.

So if one-third of mortgage-holders are virtually underwater and can’t be sold, then the result is that the number of homes being put on the market is being reduced.  Not only that, but with fewer houses for sale, the prices on those places that are available are being driven up, leaving would-be first home buyers scrounging to boost savings and delaying their entry into the market.

“The unfortunate reality is that housing markets look to be swimming with underwater borrowers for years to come,” said Zillow chief economist Stan Humphries.

“It’s hard to overstate just how much of a drag on the housing market negative equity really is, especially at the lower end of the market, which represents those homes typically most affordable for first-time buyers.

The negative equity issue is one that, unsurprisingly, is being played out at the lower end of the market.

Nearly a quarter of the homes in the $US86,101 to $US389,100 range are underwater compared to just 10 per cent above $US389,100, according to the Zillow report.

Given the precarious predicament you may be tempted to cut your losses, sell-up and rebuild. However, since Congress allowed the Mortgage Forgiveness Debt Relief Act to expire, short sellers are liable for taxes on forgiven debt. The simple supply and demand issue is also causing sellers to have way more confidence in the market than they should.

Real estate brokerage firm Redfin said 40 per cent of sellers are planning to price their homes above market value when they list this year. That is already up from 33 per cent at the beginning of the year.

While the Zillow report may not have attracted as many headlines this week, it is a red flag that should not be ignored.

What needs to happen is that supply has to improve at the lower end of the market so that first-home buyers in particular are not shut out from purchasing property that is currently being listed at higher prices then what they are worth.

Mathew Murphy is a Walkley Award-winning journalist based in New York.