The question for the newly above water borrower: to sell or not to sell

The increase of home values have pushed some 1.4 million underwater borrowers into positive equity territory.  The Federal Reserve have engineered ultra low mortgage rates and banks have suppressed the shadow inventory into “cloud inventory‘”   Meaning many homeowners will receive loan modification after loan modification leading to a false sense of confidence,  but in the long term most will end up losing their homes.

However, for these newly above water borrowers threats still remain to push them underwater again.  Whether its market risk,  balloon payment shock, mortgage rate increases,  tax law changes or even demographic changes in their neighborhood it’s probably on their mind that they could be upside down again.  Therefore, some of these borrowers are contemplating selling their home.  And selling has usually has transactions of 10%, but For Sale By Owner FSBO are becoming more popular, I’m assuming to save a few dollars.  In addition, some of these borrowers didn’t maintain the property when it was underwater, so addition repairs could be an issue on top of standard costs of sale.

Housing Recovery Bailed Out 1.4 Million Underwater Homeowners in 2012

By Meg Handley

One of the most significant effects of the nation’s housing bust has been the swelling ranks of underwater borrowers trapped in homes worth far less than they are worth.

But thanks to sustained rises in home prices, the number of homeowners stuck in the negative equity trap is dwindling. According to analytics firm CoreLogic, 100,000 borrowers edged into the positive equity territory in the third quarter of 2012, adding to the more than 1.3 million borrowers that rose above water on their mortgages through the second quarter of last year.

“The number of underwater borrowers declined significantly,” said Mark Fleming, chief economist for CoreLogic, in a press release. “The substantive gain in house prices made in 2012, partly due to tight inventory caused by negative equity’s lock-out effect, has paradoxically alleviated some of the pain.”

This housing situation is still very mortgage rate sensitive.  Any change in policy by the Federal Reserve or melt down of the dollar could increase mortgage rates.  Even a small increase in mortgage rates stalls sales and gives the buyer a stronger negotiation position.

In addition a lot of underwater or near underwater borrowers have received loan modifications that have payments that below rental costs.  These owners will not move during this teaser rate period.   Once their mortgage payments increase again they will simply default.  These homes will eventually make it on the market and could suppress home values in the future.   You don’t want to sell you house when homes start hitting the market.

Overall, 22 percent of residential properties remained underwater at the end of the third quarter, down slightly from numbers through the end of the second quarter. Still, as many as 1.8 million borrowers could have equity in their homes again over the next year if home prices continue to rise, the firm reported.

The potential sellers could save money by utilizing For Sale by Owner services, but that has some costs and risks associated with this process. If a borrower has very little equity then this would be something to squeeze that margin back into positive territory.  Notice the increase homes that are For Sale By Owner.

As the report noted, much of the progress in reducing the number of underwater homeowners depends on continued increases in home prices, a trend experts largely credit to tight inventory conditions in many parts of the country. The lack of foreclosure inventory contributed to the overall lack of inventory, with investors and hedge funds vying for a limited number of properties.

According to foreclosure information website RealtyTrac, the average discount for foreclosure properties across the nation was about 32 percent through the third quarter of 2012. While that’s still a sizable discount, according to RealtyTrac Vice President Daren Blomquist, discounts as much as 40 percent were customary just a couple of years ago.

The banks, slow judicial processes, and pro-squatter laws have prevented these home from being foreclosed upon.  This has reduce the number of homes on the market and increased the competition for the remaining homes.  This lack of supply isn’t market based, it’s managed supply to give the appearance of a seller’s market.  Again, this is another risk if banks, investors, or hedge funds decided to dump their remaining homes on the market.

But where discounts really become relevant is at a more specific, metro-area market level, Blomquist says.

“In cities that have been hit hard by foreclosures, the discount is much less than the national average,” Blomquist says. “That’s because foreclosures are such a dominant part of the market and non-foreclosures have to compete with foreclosure sellers.”

Las Vegas, which was hard hit by the foreclosure crisis, posted only a 16 percent discount on foreclosures through the third quarter of 2012 according to RealtyTrac, half the national average discount. Stockton, Calif., is another foreclosure-ridden market, and it posted just a 9.5 percent discount.

What this article didn’t state about the Las Vegas real estate market is that State of Nevada passed very restrictive and putative law against the banks.  The banks not wanting to increase liability simply reduced their foreclosure pipeline.  This dried the number of homes available on the market and large price increased that followed.  However, they are still plenty of the homes were squatters are living in.

The trend is even more stark when looking at foreclosure discounts by lenders over the past several years. At the height of the housing bust, Bank of America discounted foreclosures 34 percent on average according to RealtyTrac data. By 2012, the discount had shrunk to just 6 percent. On average, Wells Fargo offered no discount in 2012.

“The trend is that discounts are getting less and less, especially when you look through the lens of the lender,” Blomquist says. “With the shortage of inventory, they have the upper hand in getting a better price.”

There is new Qualified Mortgage or Qualified Residential Mortgage guidelines that are slowly being proposed and adopted that reduce the number of eligible borrowers.  In short, this will somewhat reduce demand by the buyers.  Watch in six to eight months when banks start to operate under these new laws.

While that might be bad news for investors looking for a deal, it bodes well for the millions of Americans still struggling with underwater mortgages and for the broader housing market and economy.

To summarized some of these are some of the threats facing the newly above water home owners if they are planning to sell.

  • Higher Mortgage rates
  • Stricter Loan Requirements
  • More homes on the market due re-defaults of loan modifications
  • Reduced mortgage interest tax deductions
  • Higher FHA mortgage insurance premiums and increases in Fannie and Freddie G-fees
  • Higher student loan debt which reduces the ability to purchase homes
  • Economy issues

All these issues probably won’t happen in 2014, but even it’s a couple of these possibilities do it adds pressure on the sellers and give advantages to the buyers.  Maybe none of this will happen and values will keep increasing.  However, if you are a newly above water home owner and want to get out consider some of these risks to your marginal equity.