When the housing market collapsed in 2008, millions of homeowners found themselves underwater, owing more on mortgages than their homes were worth.
Over the last seven years home prices have recovered – in some markets more than others – and each month more people find that the have a small bit of equity once again in their once-underwater homes.
But a report this month from Zillow shows just how much farther the housing market has to go before it fully recovers. The report found that more than half the homeowners who are still underwater are so far under they have almost no chance of re-surfacing for years to come.
This explains a lot about the housing market and the headwinds it faces in trying to get back to its pre-bubble equilibrium.
The good news
First, the good news. The rate of negative equity among mortgaged homeowners was 15.4% in the first quarter of 2015, down from 16.9% in the fourth quarter, a marked improvement. And the numbers have been improving each quarter.
But of those remaining underwater homeowners, about half -- some 4 million owners – still owe over 20% more than the value of their home. For example, if they owe $200,000 on their mortgage they could only sell their home for $168,000.
The report further found that lower-priced, entry level homes were more than three times as likely to be underwater than more expensive homes. All of this has a distorting effect on the housing market.
First, there are some four million homes that might have gone on the market in the last seven years but haven't, because their owners are essentially hopelessly trapped. These homes are concentrated in the lower end, where they would normally be purchased by first-time home buyers.
That may be partly responsible for tight inventories, which have helped prices increase because of fewer homes for sale. But it has also resulted in fewer sales, which has a ripple effect on many other types of businesses, such as home centers, decorators and furniture retailers.
Because there are millions of entry-level homeowners still underwater, they can't move up by purchasing a more expensive home, resulting in a slowdown in sales in that segment.
The recovering housing market has slowed in recent months and this may be partly why. Rising prices helped many homeowners close to the break-even point escape. Going forward, it's clear fewer negative equity homeowners will be able to get their heads above water.
Toughest situations remain
At the peak of the housing market crisis, more than 15 million homeowners were underwater on their homes. Foreclosures, short sales and rising home values freed nearly half of those homeowners, leaving 7.9 million homeowners upside down at the end of the first quarter of 2015. Zillow says the homeowners who remain underwater will likely be the toughest to free from negative equity.
"It's great news that the level of negative equity is falling, but what really worries me is the depth of negative equity,” said Zillow Chief Economist Dr. Stan Humphries. “Millions of Americans are so far underwater, it's likely they may not regain equity for up to a decade or more at these rates."
That creates a real problem for first-time buyers, the consumers who normally drive the housing market. The selection of homes they can afford is smaller than it should be because many of these homes simply can't be sold.
“And owners of those homes can't move up the chain because they're stuck underwater in the entry-level home they bought years ago,” Humphries said. “The logjam at the bottom is having ripple effects throughout the market, and as home value growth slows, it will be years before it gets cleared up.”
In the meantime, Humphries predicts the housing market will be left with volatile prices, limited inventory, tepid demand, elevated foreclosures and “a whole lot of frustration."
When the housing market collapsed in 2008, millions of homeowners found themselves underwater, owing more on mortgages tha...