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mortgage payoff, underwater mortgage, amortization, negative equity, extra payments, appreciation rate

How Long Will You Be Underwater?
June 6, 2012

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.  

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