Matt Woolsey
It's no secret that homeowners with subprime mortgages have taken a beating.
Next up: those who have combined their mortgages with home equity loans, second loans or both.
These combinations spell especially bad news for homeowners in Sacramento, Calif., San Diego, Washington, D.C., and Colorado Springs, Colo., markets with some of the nation's highest concentrations of homeowner debt. In these spots, prices are dropping, making it very difficult for homeowners to refinance as lenders are reluctant to take on risk.
Denver, Minneapolis, Los Angeles, Boise, Idaho, Las Vegas, and Madison, Wis. round out the top 10.
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We relied on U.S. Census data to determine which of the country's largest 150 housing markets had the highest percentage of outstanding home equity and second loans. Because neither on its own signifies a homeowner's level of overextension, we combined those data with housing price trends taken from the National Association of Realtors, to gauge which markets are experiencing steep price drops. Homeowners in these areas might have the hardest time refinancing or staying afloat.
An inability to refinance makes homes more likely to fall into foreclosure because in this situation, properies enter negative equity situations more easily; this occurs when a property is worth less than the outstanding loan on it.
Of course, it's difficult to say just how these homeowners will fare in the coming months, because there's no history of these loans in a market slump.
"Second home mortgages and home equity loans are a phenomenon of the last 15 years," says William Wheaton, an economics professor at the Massachusetts Institute of Technology. "You'd be hard pressed to see their track records during housing downturns."
What is clear is that the popularity of these loan products has grown in that time period. By the Federal Reserve Board's count, the total amount of outstanding home equity loans grew from $260 billion in 1995 to $970 billion in 2005. Homeowners love these sorts of loans in an up market because they get cash in hand, and they can deduct the interest.
It's when you start to combine home equity loans, second mortgages and a falling market that things get dicey.
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Consider Denver, where 29% of mortgage holders have either a home equity loan or a second mortgage, or both--the highest rate in the country. Like home equity loans, second mortgages are often taken out for immediate cash or, in many cases during the housing boom, as a way to cover a down payment. Borrowers armed with such "piggyback loans," bought homes without any money, only credit.
That's a good deal when values are rising. When they fall, these homeowners are particularly vulnerable to foreclosures because without any equity in their homes, market downturns put them underwater. Denver has the country's ninth-highest foreclosure rate, despite a healthy economy in which the job market is growing.
"In these communities it's going to be much harder to keep people from losing their house to foreclosure," says John Vogel, an Adjunct Professor of Business Administration at Dartmouth's Tuck School of Business.
When homeowners in a negative equity situation try to short a property, they have to negotiate with all of their lien holders (first mortgage, second mortgage, home equity loan). Vogel says homeowners "have to get more people to sit around a table and agree to a deal. The more people, the more complicated it is to get things worked out."
Slumping home prices mixed with home equity lines of credit and second mortgages also signal a slowdown in local economies, since the loans are often used for home improvements or big-ticket items.
"People took money out of their homes to spend it," says Scott Hoyt, director of consumer economics at Moody's Economy.com. "There are significant, negative implications for contractors and retailers because consumers will be drastically cutting back on their spending."
