About 16 million homeowners owe more on their mortgage than
their homes are worth — they are “underwater.” So long as
that condition continues, they have no equity that can be
used to help finance the purchase of another house. On the
contrary, they can’t sell the house without digging into
their pockets to pay the difference between what they owe
and what they can realize from the sale net of expenses.
But time heals
most wounds and negative equity is no exception. The
principal component of the monthly mortgage payment reduces
the loan balance by the same amount. Refinancing into
a mortgage carrying a lower interest rate reduces the
interest portion of the monthly mortgage payment, thereby
increasing the principal component and the rate at which the
balance is paid down.
Although
underwater borrowers generally can’t qualify for a
refinance, those fortunate enough to have their mortgages
held by Fannie Mae or Freddie Mac comprise an important
exception. The HARP refinance program of the agencies
permits negative equity, though borrowers must be in good
standing to be eligible.
The other
component of negative equity, depressed home prices, also
appears to have turned the corner. Prices have begun to rise
again in some areas in which the houses listed on the market
have fallen short of demand from purchasers. It is plausible
that within the year home prices in most areas will again be
on the rise.
It is now time
for underwater borrowers to start planning to get their
heads above water. To help in that process, Chuck
Freedenberg and I have designed two calculators designated
2d and 2e on my web site. The first shows the borrower’s
equity in the property month by month for any combination of
the various factors that affect changes in equity. These
include the interest rate, property appreciation rate, and
extra payments. See
Calculator 2d
and calculator 2e.
Some examples are shown in the table.
Changes In Negative Equity With Initial Loan Balance of $200,000, Property Value of $150,000, and Monthly Payment of $1300
|
Factors Affecting Change in Equity |
Month When Equity Reaches: |
||||
|
Interest Rate |
Appreciation Rate |
Extra Payments |
0 |
10% |
20% |
|
6% |
0 |
0 |
122 |
148 |
170 |
|
6% |
1% |
0 |
98 |
123 |
147 |
|
6% |
1% |
$50 |
89 |
112 |
134 |
|
6% |
2% |
$50 |
74 |
95 |
116 |
|
6% |
2% |
$100 |
68 |
88 |
108 |
|
4.5% |
0 |
0 |
79 |
99 |
117 |
|
4.5% |
1% |
0 |
67 |
86 |
104 |
|
4.5% |
1% |
$50 |
63 |
80 |
97 |
|
4.5% |
2% |
$50 |
55 |
71 |
87 |
|
4.5% |
2% |
$100 |
52 |
67 |
83 |
The table
shows, for different combinations of interest rate,
appreciation rate and extra payments, when the borrower will
no longer be underwater, which is the month when equity hits
zero. The table also shows how long it will take before
equity hits 10%, at which point the borrower who is
otherwise qualified will be able to refinance, and 20% where
a refinance won’t require mortgage insurance.
Borrowers may
want to raise their targets to cover the expenses of
whatever action they plan. If the goal is to sell the house,
for example, they will need positive equity of 5-7% to cover
sales costs. This is easy to find with the calculator.
The second
calculator is designed for underwater borrowers who want to
know how much extra they have to pay each month to reach a
target equity level within a specified period. For example,
the borrower paying 4.5% in the example above wants 10%
equity in 5 years and believes his house will appreciate at
a rate of 1% a year. The calculator tells him he must pay an
additional $315.50 every month for 60 months to reach his
objective. If his house does not appreciate, he has to pay
$418.05.
While the
calculator tells you what you must do to reach your
objective, it doesn’t tell you how to develop the commitment
and determination to see it through. I am working on that.
