Nearly one in three US homeowners owe more on mortgage than their home is worth

May 7, 2009 | 10:39 AM

The downturn in home prices has left about 20% of U.S. homeowners owing more on a mortgage than their homes are worth, according to one new study, signaling additional challenges to the Obama administration’s efforts to stabilize the housing market.

The increase in the number of such “underwater” borrowers comes amid signs that falling prices are making homes more affordable for first-time buyers and others who have been shut out of the housing market. But falling prices also make it more difficult for homeowners who get into financial trouble to refinance or sell their homes, and for others to take advantage of lower interest rates.

For instance, fewer will qualify to take advantage of a key component of the Obama administration’s plan to stabilize the housing market. Under the plan, announced in February, as many as five million homeowners whose loans are owned or guaranteed by government-controlled mortgage giants Fannie Mae and Freddie Mac can refinance their mortgages, but only if the mortgage loan is a maximum of 105% of the home’s value.

Government officials are considering an increase in that limit. “It’s a question that we’re looking at,” said James Lockhart, director of the Federal Housing Finance Agency, which regulates Fannie and Freddie.

Real-estate Web site Zillow.com said that overall, the number of borrowers who are underwater climbed to 20.4 million at the end of the first quarter from 16.3 million at the end of the fourth quarter. The latest figure represents 21.9% of all homeowners, according to Zillow, up from 17.6% in the fourth quarter and 14.3% in the third quarter.

“What’s going on here is that you don’t have any markets that have turned around and you have new markets, like Dallas, that have joined the ranks” of communities where home prices have fallen, said Stan Humphries, a Zillow.com vice president.

Borrowers who owe far more than their home is worth may also be less likely to participate in another part of the government’s housing plan, which provides incentives for mortgage companies to modify loans to make payments more affordable. Thomas Lawler, an independent housing economist, said borrowers who owe 30% more than their homes are worth are far more likely to walk away from their property than those who owe just 5% or 10% more and expect prices to rebound. More than one in 10 borrowers with a mortgage owed 110% or more of their home’s value at the end of last year, according to First American CoreLogic.

There are some recent indications that the housing market could be beginning to stabilize. The National Association of Realtors pending home-sales index, for instance, increased 3.2% in March.

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Just how many borrowers are underwater is a matter of some dispute, with the answer depending in part on assumptions regarding home values and mortgage debt outstanding. Variations in home-price estimates can make a major difference in the number of borrowers who are underwater. In addition, borrowers who are already in the foreclosure process may be counted as being underwater if the title to their property hasn’t changed hands.

Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley, said underwater estimates can be too high if they use price data that includes a large number of foreclosures. Foreclosed homes tend to sell at a discount, he said, making it appear that prices have fallen more than they actually have.

Moody’s Economy.com estimates that of 78.2 million owner-occupied single-family homes, 14.8 million borrowers, or 19%, owed more than their homes were worth at the end of the first quarter, up from 13.6 million at the end of last year.

Part of the reason Zillow’s numbers are higher may be that it looks at mortgage debt taken out at the time the home was purchased and doesn’t adjust for any payments since made toward the outstanding mortgage balance. It also assumes that borrowers who took out home-equity lines of credit at the time of purchase have fully tapped the amount they can borrow. That approach can overstate the portion of borrowers who are underwater, Mr. Zandi said.

Mr. Humphries of Zillow calls his methodology conservative and said Zillow’s use of pricing for individual homes provides a better measure of home valuations than Mr. Zandi’s approach, which relies on market-level estimates of home values. He adds that Zillow doesn’t include foreclosures in its pricing models.

Write to Ruth Simon at ruth.simon@wsj.com and James R. Hagerty at bob.hagerty@wsj.com