Home Equity: Why 2015 Is The New Zero

Underwater? How Long Will It Take to Build Back Your Equity?

One of the hottest topics in the mortgage industry these days is strategic defaults, or borrowers who decide to "walk away" from their mortgages. Often times, these borrowers are so far underwater - owing more than what their home is worth - that they see no other option than to abandon their contract. In a country that has experienced home-price declines of some 30% in about three years, according to Fiserv Lending Solutions, thousands of American homeowners have seen the equity in their homes all but disappear.

Lew Sichelman wrote an excellent piece for the trade publication National Mortgage News citing a fresh study which explored the likelihood that an underwater borrower would walk away from their home, even if they could afford to make payments.

The article noted that "fewer than one in 1,000" borrowers would mail in the keys with just a 10% deficit, only 5% would walk away with a gap of 10% to 20% and only 17% would go voluntarily without selling if they were 50% underwater. Sichelman's take is that 'strategic defaults' are "well-reported, if not well documented." We agree; the number of homeowners defaulting by choice is probably quite small relative to the problem as a whole.

But what about those who stay? What happens to them?

Given that a sizable chunk of the population is perhaps 10% to 20% underwater, we thought we'd run a few quick calculations to see what the 95% of borrowers who stay put might face in their financial futures.

We needed to make a few assumptions, of course. A borrower who bought a $200,000 home in January of 2006 with a fully-amortizing, fixed-rate mortgage at 6% with a 5% down payment probably saw a little lift in prices for that year, overall, but the softening of home prices was already getting underway by late in the year.

However, for the sake of argument, we've ascribed a 10% annualized decline in value from Jan 2006 through October 2008, then a 5% annualized rate though November of 2009 (we realize the declines have been nowhere as even or regular as these but the effect should be roughly the same). Doing so put our borrower at a loan-to-value ratio of almost 127% -- deeply underwater and certainly at a level where one might consider walking away.

We can't say for sure what will happen with prices in the future, but since there have been some signs of leveling off, we assumed that through June 2010 there will feature a 0% rate of increase or decrease, followed by a 14-month period of 2% annual price increases, then a 12-month period of 2.5% gains before finally settling in to a flat 3% annual increase going forward.

Following this pattern, a borrower would finally come back to a 100% LTV level in May 2015. That is, they are back to a 0% equity level, where the value of their home is equaled by the amount they still owe on their mortgage... better than 10 years into making payments. Worse, even though they are finally at 0% ownership, the value of the home is almost $39,000 below their starting point.

Hoping to refinance? It'll be a while. Although FHA loans require only 3.5% equity in the property (and assuming they still will, and that rates are favorable at the time), a chance to do so will come along in about November of 2015. Remember, you're also building equity by retiring some of your loan balance, too; you can find out where your loan will be at different points in time by utilizing an mortgage calculator.

Want to sell without needing to pony up cash out-of-pocket? At a continuing 3% appreciation clip, it will take you another 13 months of making regular payments to cover the typical 6% sales commission, but at least you'll get out without paying... but you'll still be about $33,000 in the hole since the home would only be worth about $167,000 by then.

Figure you'll hold on until you get back to the original $200,000 value? Better plan for the long haul. If we continue the 3% run of annualized appreciation, you'll get back to the home's original $200,000 value in July of 2022, some 17-plus years after you bought it.

Of course, these may or may not be realistic assumptions. Home values may move upward more strongly or more weakly which of course would change the time frames somewhat, either shorting or lengthening them as appropriate. Mortgage products which delay the payment of principal - such as interest-only loans - will of course affect the recovery time, too.

No wonder loan modifications are popular. Given the deep hole many borrowers are in and the long, long recovery of value and equity that lies ahead is it any wonder that so many borrowers who are still in good straits are contacting their servicers for a loan modification? Mary Collin, Wells Fargo's VP of Mortgage Servicing, noted in an October 2009 interview in the Servicing Management magazine that requests from homeowners still current on their mortgages but seeking modifications comprised about 40% of the calls they are receiving.

The "can't sell without a loss" and "can't refinance" problem is likely to be around for years. As we move into the future, expect mortgage servicers to place more emphasis on deed-in-lieu and short-sale programs. For the most part, homeowners who bought near (not even at) the peak of the market will continue to find mortgage troubles well into the future.