Underwater Mortgages Increase, but No Break for Borrowers

According to a new report by Deutsche Bank, and investment firm, the number of borrowers with underwater mortgages – those who owe more on their mortgage than their homes are worth – is projected to skyrocket in the next few years. This proportion, “will nearly double to 48 percent in 2011 from 26 percent at the end of March, portending another blow to the housing market.”

Deutsche Bank didn’t offer much in the way of context/analysis for its figures, which is somewhat surprising since several indicators of the housing market have begun to tick up. Regardless, the projections are eye-opening, to say the least. Everyone already knows about the problems affecting the riskiest class of mortgages. With regard to subprime loans, “69 percent will be underwater in 2011, up from 50 percent in March, Deutsche said. Of option adjustable-rate mortgages — which cut payments by allowing principal balances to rise — 89 percent will be underwater in 2011, up from 77 percent.”

Those following the housing market probably would have also anticipated that some of the most distressed regional markets would see a rising percentage of underwater mortgages, many of which were no doubt funded using the risky mortgages cited above. For example, “Las Vegas and parts of Florida and California will see 90 percent or more of their loans underwater by 2011.”

Few, however, would have expected such dire predictions for prime loans, which “make up two-thirds of mortgages, and are typically less risky because of stringent requirements.” As a result of a projected 14% price decline up to  41% of prime conforming loans may be characterized by negative equity by 2011. “Forty-six percent of prime jumbo loans will be larger than their properties’ value, up from 29 percent, it said.”

Most troubling, perhaps, is the notion that such borrowers won’t receive a break from lenders, nor from the government. Currently, the practice of reducing one’s mortgage (known as a cram-down) as a result of personal bankruptcy, remains taboo as a result of industry pressure. “House Financial Services Committee chairman Barney Frank (D-Mass.) has already warned that if more loans aren’t worked out, he’ll renew the push to allow bankruptcy judges to order reductions in mortgage amounts.”

In fact, government legislation appears to be moving in the opposite direction. Arizona, for example, is contemplating changing its laws on deficiency judgements, which currently serve to prevent a lender that “forecloses on a home mortgage to recover the balance of what is owed the lender if the foreclosure sale doesn’t produce the full amount…The changes, which haven’t yet taken effect, impose new eligibility requirements to qualify for protection against a deficiency judgment. One is that the borrower must have lived in the property for six consecutive months.” If this takes effect, then borrowers that walk away from their underwater mortgages might see the balance stay with them forever. What’s next – a return to the days of debtor prisons?