Negative equity is playing a critical role in the reduction of job mobility and emergency funds for homeowners. This phenomenon is estimated to effect more than 7 million homeowners.
What is negative equity? This is the term for what happens when you buy a home, but the price of your home drops below what you owe on your mortgage. If you want to sell your home in this type of environment you don’t just take a loss you have to come up with cash to pay off your mortgage holder upon completion of a sale. If you wanted to access the equity in your home for repairs or other emergencies you will be unable to because you no longer have positive equity. Essentially the borrower has no resources from which to draw from in an emergency. This has been a key component to an increasing amount of foreclosures.
This trend is typical in automobile purchases. It is not uncommon to see negative equity soon after the purchase of a new vehicle. When a car owner wants to trade up they either have to add to their loan request to cover negative equity in their trade or bring cash to cover the difference. Alternatively they can hold on to their vehicle until they have paid down enough on the loan to realize positive trade in value.
However, when it comes to home loans most borrowers never anticipated depreciation in value and are ill equipped to deal with the disparity.
CNNMoney.com indicates some states have as much as 39% of their homeowners who are in a negative equity situation.
What this means in real terms is homeowners can’t sell their property until they have significant cash reserves to cover the difference. They can’t accept a job in a new location because they can’t sell their home. They can’t make improvements to the property and the threat of foreclosure remains a persistent threat.
It is in this climate that the U.S. government is looking at enacting a new program aimed at helping about 3 million of those ‘at risk’ homeowners.
Sources indicate nearly $50 billion could be earmarked to help homeowners deal with the pressure of home ownership in the current financial crisis.
According to CNN, “Three administration officials indicated … that the new program would be designed to prevent foreclosures by having lenders reduce delinquent borrowers' mortgage payments to affordable levels. In exchange the government would guarantee some percentage of each loan to backstop lenders if borrowers re-default on modified mortgages.”
One of the proposals that have been voluntary thus far is for lenders to reduce mortgage payments to 33-38% of the family’s annual income. This applies to mortgage, insurance and property taxes. This could be handled as a loss to the lender or in some cases accomplished by adjusting the terms of the loan. This adjustment will generally take the form of a maturity date that is a bit further into the future.
Some programs considered by lawmakers and the mortgage industry would allow them to write down the loan to current economic values, but there remains a concern that this would further hurt the economy because it would constitute a greater loss for lenders than they may be able to absorb.
The massive scale of defaults and the voluntary nature of lending programs have contributed to the economic crisis according to many analysts. Add in growing jobless claims and you begin to gain a clearer picture of the multifaceted stress created by foreclosure.
Perhaps the bright news for homeowners is the fact that the mortgage companies want to help their customers. The mortgage company loses money every time they have to foreclose because these homes often sit vacant with very few who are able to buy. In other words the mortgage companies have strong reason to help borrowers stay in their homes.
