© 2012, Adam J. Levitin
The research and conclusions expressed in this paper are those of the author(s)and do not necessarily reflect the views of Pew, its management or its Board.
who are in turn 27.1 percent of all residential mortgages.
The averageunderwater borrower is upside down by $65,000 on a loan with a $256,000 balance,
although there is considerable variation among states (and presumably within states); inCalifornia, the average underwater borrower is upside down by $93,000.
To put thesefigures in some perspective, the median annual household income in the United States in2009 was $49,777,
meaning that the average amount of negative equity is considerably
greater than most households’ annual disp
osable income. The depth of negative equity islikely to increase as housing prices drop due to foreclosure sales and lack of upkeep onunderwater properties by homeowners who see no reason to spend on taking care of properties in which they have no equity.Negative equity matters first and foremost because it prevents the market fromclearing. People need to be able to sell and buy homes. Normal life-cycle eventsnecessitate relocation, meaning both sales and purchases: employment changes, divorce,disability and illness, death, children, etc. These home sales and purchases cannot occur,however, unless the market is clearing.In a functioning market, willing buyers and willing sellers meet and agree on aprice. When they do the deal, the market clears at the deal price, and welfare is enhancedwhen parties are able to enter into exchanges that they both see as value enhancing.
Based on the parties’ revealed
preferences, the exchange is Pareto efficient. The problemwith the housing market, currently, is that even when willing buyers and willing sellerscan agree on a price, they often cannot close the deal because there is a mortgage on theproperty for more than the deal price.To wit, if someone agrees to buy a house for $200,000, it is impossible to closethe deal if there is a $265,000 mortgage on the house. Virtually every mortgage contains
sale” clause that accelerates the entire debt upon sale.
Therefore, unless thehomeowner has other resources from which s/he can pay off the difference between the
mortgage debt and the sale price (the “deficiency”), the mortgage lien would remain on
the house, which would permit the lender for foreclose on the
unless the buyer paysoff the remaining $65,000.In such circumstances, few, if any, people are willing to buy; they would, bydefinition, be overpaying for the house. Put differently, the buyer must pay for both thehouse and the deficiency in order to obtain the house. The result is that even though thebuyer and seller can agree on the value of the
, they cannot complete the dealbecause of the additional cost of the deficiency. Thus, the market does not clear.The root of this market-clearing problem, then, is that mortgages, unlike houses,
(calculations by author, averaging first-lien only and first-line plus junior lien data).
U.S. Census Bureau,
http://quickfacts.census.gov/qfd/states/00000.html. There are goodreasons to believe that median income is based on unreported income, but the basic point remains
negative equity is
still much larger than underwater households’ income.
State prohibitions on due-on-sale clauses were generally preempted by the Garn-St.GermainDepository Institutions Act of 1982,
12 U.S.C. § 1701j-3.