Underwater mortgages drop by 1.3 million. How much could that boost the economy?

September 17, 2012

One of the big drags on the U.S. economy right now is the housing market. Among other problems, about 10.8 million Americans are "underwater" on their mortgages right now — these are homeowners who owe more than their houses are currently worth.


Mark R. Rummel (AP)

Why is this a problem? For starters, underwater homeowners are more likely to fall into foreclosure, further depressing the housing market. Second, these homeowners can't sell their homes and move without incurring a steep financial penalty. That's a big impediment for young people who might want to seek jobs elsewhere  — the research firm Zillow has estimated that nearly half of homeowners under the age of 40 are underwater right now. And it's a drag on states like Nevada, which has both high underwater rates and high unemployment.

What's more, the high number of underwater homeowners are a potential obstacle in the way of the Federal Reserve's efforts to stimulate the economy. The Fed has recently pledged to buy up $40 billion worth of mortgage-backed securities each month between now and the end of the year in order to reduce mortgage-lending rates. The hope is that many homeowners will refinance at the lower rates, putting more money into their pockets so that they can go spend and stimulate the economy. But underwater homeowners often have difficulties refinancing, which puts a damper on these efforts.

That's why it's fairly positive news that, according to a new report (pdf) from CoreLogic, nearly 1.3 million Americans reached "positive equity" this year. They're no longer underwater. That's a big change. As Jared Bernstein points out, if many of those Americans start refinancing their homes at low rates, "that will constitute a substantial stimulus to the macro-economy, worth potentially hundreds of billions of dollars."

On the downside, however, it still leaves 10.8 million Americans, or 22.3 percent of all homeowners, underwater. (In a healthy housing market, typically just 5 percent or so of homeowners are underwater.) Here's where they're located:

Earlier this year, the Obama administration revamped a program, the Home Affordable Refinance Program (HARP), to try to help many underwater homeowners refinance. (Originally, the program was only aimed at those who owed up to 125 percent of the value of their home, but that cap has now been lifted.) So far, the program appears to be gathering some momentum, as refinancing rates have gone up.

But that program only helps those homeowners whose mortgages are owned by Fannie Mae or Freddie Mac, so it can't reach everyone. Mike Konczal recently wrote a long post outlining a number of things that Congress and the White House could do to speed the process up—from reducing the principal of loans to modifying bankruptcy law. As one example, Senator Jeff Merkley (D-Ore.) has put forward a proposal to help an additional 8 million underwater Americans who can't currently refinance.

Without additional measures, it's unlikely that we'll see a truly massive, economy-boosting wave of refinancing until home values start rising and the amount of "negative equity" that American homeowners have shrinks. That's starting to happen on its own this year, albeit at a fairly slow pace.

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Ezra Klein · September 17, 2012