Even with recent gains 44% of homeowners with mortgages still lack equity for a trade up house

This week if you followed housing news it was a buzz with the double digit year over year Case Shiller index increase.  This is the biggest gain in six years, but there are still major problems in the housing sector.  One glaring problem that came out this week (besides shrinking affordability) is that over 40% borrowers don’t have enough equity to trade up to a larger or more expense home.  In addition, the current cost of ownership is nearing the cost of renting and in some places owning now more expensive getting closer to historical premium.

This lack of equity means the trade up market will be suppressed for a very long time and it’s anyone’s educated guess when a normal housing market will return.   When housing analysts discuss the “recovery” of the housing market there is never a mention to the “trade up” condition of the housing market.  Yes, the argument can be made the house market is valued more, but not a recovery and the trade up market will be in a slump for years.  In addition, this not some little niche in the housing market over 75% home buyers want to a larger house or nicer neighborhood.

Millions of Above-Water Borrowers Lack Enough Equity to Move

According to the report, the national negative equity rate was 25.4 percent in the last quarter compared to 27.5 percent at the end of 2012. That percentage represents slightly more than 13 million homeowners with a mortgage, Zillow said.

However, when including homeowners with less than 20 percent home equity, the “effective” negative equity rate climbs to 43.6 percent, or a total of 22.3 million homeowners.

The cost-of-sale is usually about 10% for the seller and if the seller has major repairs discovered during the inspection process it can hit 20% cost of sale with price concussions to the buyer.  This 20% is the worse case scenario.  However, if you sell and get earn 10% from the sale of your house is  that really trade up equity?  With the suppression of the housing supply, some buyers are putting all cash and the leveraged buyers are putting a down payment of 30% more.  How can your 10% equity earnings complete with new buyers that have a 30% downpayment in the trade up market?  In the current market, trade up equity is now greater than 30%.

In its report, Zillow explained that these homeowners likely can’t afford a down payment for a new home, tying them to their current homes and exacerbating the inventory shortage.

“Reaching positive equity, even barely, is an important milestone. But things like real estate agents’ fees and a down payment for the next home traditionally come out of the proceeds from the prior home’s sale,” said Zillow chief economist Dr. Stan Humphries. “Without enough equity, these costs will instead have to come out of a homeowner’s pocket, leaving many still stuck.

Last weekend I wrote about having home owners that refuse to leave their underwater homes actually damages the economy.  It’s the lack of mobility of labor results in higher unemployment which ultimately impacts the whole economy.  This low equity model works well for the banks but they can hold the house until values increase and get some mortgage payments, but at the cost of everyone else.

“Looking at the effective negative equity rate could explain why recent, healthy declines in the number of underwater borrowers haven’t yet translated into more homes for sale. The only cure is patience, as rising home values continue to build equity to the point where more homeowners can realistically sell,” he continued.

Among the 30 largest metro areas covered by Zillow, those with the highest effective negative equity rate are Las Vegas, Nevada (71.5 percent); Atlanta, Georgia (64.1 percent); and Riverside, California (59.7 percent).

If you are reading this blog from Riverside and have mortgage there is a 60% chance you are just “title renting”.  Again, this is just another example why home value won’t increase in the future.  Larry also documented that most investors want to sell their investment homes within six years.  That’s a lot of shadow inventory to be slowly managed coming on the market over a long period.  The lack of homeowner equity problem feedbacks into the lack of supply problem.  It’s all interrelated.

For the first quarter of 2014, Zillow predicts the negative equity rate among all homeowners with a mortgage (but excluding those who are in low positive equity) will fall to 23.5 percent, lifting more than 1.4 million additional homeowners into positive territory.

Most people can’t live in the same house for 20 years due to family, divorce, employment, or retirement changes.  The end result of this marginal equity problem is that people with live in these homes and then sell after 10 years with little or most likely no equity.  Really it’s the same as renting except you have a tax deduction for the mortgage interest, but you are also responsible for the maintenance.  That’s where the term “title renting” comes from, the homeowner never develops equity, they rent the privilege from the County Recorders by putting their name on the title while renting money from the bank.