Deutsche Bank: Half of U.S. Homeowners with Mortgages Will Be 'Underwater' by 2011

Deutsche Bank estimates that 14 million, or 26 percent of homeowners with mortgages, owed more than their house is worth in the first quarter of 2009. An estimated further 14 percent decline in home prices will drive up the number of homeowners with negative equity to 25 million or 48 percent of mortgagors by the first quarter of 2011, the bank forecasts.

By Robert Stowe England
August 20, 2009

Hopes that the housing market is now beginning to stabilize have been dampened by the release of a Deutsche Bank forecast on the level of negative equity among U.S. homeowners with mortgages.

The study, "Drowning in Debt -- A Look at 'Underwater' Homeowners," was authored by Karen Weaver and Ying Shen at Deutsche Bank's U.S. research unit and can be found at this link:

Based on analysis of data on 6.7 million non-agency loans compiled by First American CoreLogic's LoanPerformance and 5.5 million loans in Freddie Mac's loan level agency data, the Deutsche Bank researchers estimate that 14 million households with mortgages were "underwater" in the first quarter of 2009.

Of the 110 million households in the United States, 75.5 million are homeowners and 68 percent of this group, or 51.6 million households, have mortgages on their homes, the report states.

Thus, the 14 million "underwater" households represent 26 percent of all homeowners with mortgages.

By 2011, however, Deutsche Bank estimates this will rise to 25 million or 48 percent of all mortgagors, a staggering increase in "underwater" households that is likely to be a considerable drag on economic prospects.

Deutsche Bank's estimate is based on its June outlook for home prices in the top 100 Metropolitan Statistical Areas, which can be found at this link:

Deutsche Bank forecasts that home prices would fall an additional 14 percent on a national level from the prices in the first quarter of 2009, reaching a bottom or trough at the end of the first quarter of 2011 -- about six quarters from now.

This forecast means that , from their peak in 2005 to the trought in early 2011, U.S. home prices will have fallen 41.7 percent, according to Deutsche Bank.

Deutsche Bank's first quarter 2009 estimate of the number of underwater households is similar to the 15 million estimated by for the first quarter and to the 11 million estimated by First American CoreLogic in the fourth quarter of 2008.

However, Deutsche Bank's forecast is decidedly more pessimistic than the one made in June by, which projects 18 million "underwater households" at the peak. The study by Mark Zandi can be found at this link:

The's estimates are based on credit file data from Equifax. Also, sees only a further 9.8 percent decline in home prices from the first quarter of 2009.

Prime Loan Deterioration Ahead

Deutsche Bank looks at the problems with negative equity by loan product type and sees deteriorating conditions even for prime credit quality home borrowers.

"While subprime and Option ARMs are currently the worst cohorts with underwater borrowers, we project that the next phase of housing decline will have a far greater impact on prime borrowers," the Deutsche Bank report states.

Option ARMs (adjustable rate mortgages) allow customers to choose among several payment levels each month with a minimum payment that, depending on the prevailing interest rate, can add additional mortgage debt to the principal, reducing the equity in the home.

Even for the most conservative category of loans -- so called conforming, conventional loans -- the share of homeowners with these loans who are underwater will rise from 16 percent in the first quarter of 2009 to 41 percent in the first quarter of 2011.

These conforming loans meet the underwriting guidelines of Fannie Mae and Freddie Mac and fall below a conforming loan limit amount, are within a debt-to-income ratio limit and are fully documented.

About 29 percent of homeowners with prime jumbo loans, those held by prime borrowers but which are above the loan limits for Fannie Mae and Freddie Mac, were already underwater early this year. By early 2011, 46 percent will be underwater.

The silver lining, if one can call it that, is that the share of underwater borrowers in nontraditional loans is already sky high. For example, 77 percent of homeowners with Option ARMs were already underwater in the first quarter of 2009. By the end of the first quarter of 2011, 89 percent will be underwater.

Option ARMs would, thus, take the prize as the most toxic of mortgage products.

Subprime loans are not far behind. While 50 percent were underwater in the first quarter of 2009, 69 percent will be underwater by early 2011.

Homeowners with Alternative-A or Alt-A loans, which have less documentation the conventional mortgages, are almost as deeply underwater as those holding subprime loans.

Deutsche Bank estimates that 50 percent of Alt-A homeowners were underwater early this year and that by early 2011, 66 percent will be underwater.

What may be almost as troubling is that the homeowners included among those with positive equity include "borderline" homeowners whose loan to home value ranges from 90 percent to 105 percent. That represented 23 percent of homeowners in the first quarter -- pushing the combined negative equity and borderline equity to 49 percent.

In 2011 the mortgages with combined negative equity and borderline positive equity will be 69 percent.

The Worst Markets

Deutsche Bank also looks at 371 MSA's and makes an estimate of how many mortgagors are currently underwater. MSA's are Metropolitan Statistical Areas, which the U.S. Census Bureau defines as one more more adjacent counties with an urban core of at least 50,000 people.

Since Deutsche Bank only forecasts home prices for the top 100 MSA's in June, for its estimates of underwater homeowners, it applies the national average of home price declines in its forecast to the remaining 271 MSA's.

This method of forecasting may overstate the share of underwater mortgagors for 2011 because the worst price declines have occurred in the major metropolitan areas. One couuld make a credible case that the smaller MSA's would have average price declines below the average found in the top 100 MSAs.

In any case, Deutsche Bank finds the highest level of underwater homeowners in the states where price appreciation was the greatest during the bubble period.

Topping the list for underwater mortgagors in earlhy 2009 are three central valley California MSAs: Merced (85 percent), El Centro (85), and Modesto (84). Las Vegas, Nevada (81), and Stockton (81) Bakersfield (79) in California, and Port St. Lucie in Florida (79) are next in line.

As for the peak in 2011, Ft. Lauderdale-Pompano Beach-Deerfield Beach, Florida will top the list at 93 percent of loans underwater, according to Deutsche Bank. El Centro (92 percent) and Merced (91) in California, and Miami-Miami Beach-Kendall, Florida (90) and West Palm Beach-Boca Raton-Boyton Beach, Florida (90) are next in line.

Copyright © 2009 Robert Stowe England


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