As housing prices continue to fall and more and more homeowners are faced with negative equity or "underwater" positions, banks that hold second mortgage and equity line portfolios may soon feel a crushing blow. Zillow.com reported today that 21.8 percent of all U.S homes -- more than 16 million residences -- owed more on their home than the home was worth. Some say Zillow's computations are a bit high, but even Moody's Economy.com puts that number at 14.8 million underwater as of the end of March.
How does this impact the banks and credit unions? All banks and credit unions that hold second mortgages or equity lines on homes underwater are likely to lose a large portion if not all the money at stake. When a bank forecloses on a house underwater, the back taxes get paid first, then the first mortgage hold gets paid. The holder of a second mortgage or equity line only gets paid only if there is money left over.
Facing this reality in 2007, mortgage companies started to walk away from delinquent home-equity loans rather than forcing a borrower into foreclosure. At the same time they scaled back making any new home equity loans.
Banks haven't given up on collecting the money in the future and some still carry the loan on their books. They do typically have a lien on a property and if the property changes hands they could get some of their money back at the time of sale. That will depend upon whether there is any money left over after the tax is paid and the first mortgage holder gets paid.
In a story last year Bob Caruso of Bank of America told The Wall Street Journal, "More often now than ever before we are writing off the loan" when borrowers fall behind on home-equity payments. "The customer still owes the money, but it is no longer an asset on the our books."
Home equity loans exploded as the housing bubble inflated, getting as high as $1.1 trillion in 2007, according to the Federal Reserve. But, how many of the $1.1 trillion loans have been written off and how much more will need to be written off as house prices continue to plummet? I couldn't find any current studies that answered this question.
Lenders try to protect themselves by freezing, reducing or closing equity lines even before a person shows that they are having trouble. Banks are managing their equity lines in the same way as they manage their credit cards. They track their customers' credit behavior. If they find someone with negative marks on their credit file, even if their equity line payments are on time, they'll reduce or close the equity lines. Equity lines could also be at risk of being closed or frozen if a borrower has less than 20 percent equity in their home.
Given the numbers from Zillow and Moody's, I'll bet banks get even more aggressive in finding ways to protect themselves from what could be an oncoming train wreck as more people stop paying on equity lines. Some of the hardest hit areas according to Zillow include Las Vegas, where 67.2 percent of homeowners are underwater and would need to bring cash to the table to sell their homes. Two other markets is big trouble are Stockton, CA, which has 51.1 percent of homes underwater and Modesto with 50.8 percent of homes underwater.
South Florida's house prices have fallen to levels last seen in 2002 or 2003, so anyone who bought a home there after 2004 will likely have a mortgage underwater unless they put a significant amount down on the home. Arizona is another with house prices falling about 50 percent in some areas.
As prices continue to spiral downward even more banks will be looking at equity lines underwater. The big question is how many of these banks have written down these assets and how many may still have to accept this bad news and report it?
Lita Epstein has written more than 25 books including, The 250 Questions You Should Ask About Buying Foreclosures.
One in five US homes underwater, putting more pressure on banks