The share of mortgaged homes with negative equity in California fell to 2.0% in Q4 2019, down from 2.4% a year earlier. Going into 2020, California has the fewest underwater properties since the Millennium Boom. However, the social and economic impacts from the coronavirus (COVID-19) are still emerging. Depending on how long they last, California’s shelter-in-place measures may induce home prices decline in 2020, which will result in a rising number of underwater homes.

Home sales volume has declined abruptly in spring 2020 as buyers and sellers wait and see what the economic impact will be on their personal finances and the housing market. If the sales slump lasts more than two-to-three months, expect to see home prices fall, too.

A caveat: mortgage interest rates fell to historic lows in March 2020, with the possibility of falling even further if the Federal Reserve (the Fed) chooses to go negative later this year. Lower interest rates increase buyer purchasing power, which directly boosts home prices. Lower rates may be enough to keep home prices afloat, which will keep most homes in their current positive equity status.

Real estate professionals who keep an eye on interest rates and home prices in the coming months will be prepared for the potential increase in underwater homes, which will translate to more distressed sales. Prepare for this possibility now by researching rules and practices for assisting clients with foreclosures, short sales and real estate owned (REO) properties.

Updated March 31, 2020. Original copy published November 2012.

Chart update 03/31/20

Q4 2019
Q4 2018
Q4 2017
Share of homes with negative equity
2.0%
2.4%
3.0%

Underwater homeowners are not alone

As of Q4 2019, just 2.0% of California’s mortgaged homeowners owed more on their mortgages than the value of their homes. These California homeowners are underwater.

The negative equity share varies by state and particularly by neighborhood. While California’s share of negative equity homes stands at 2.0% in Q4 2019, the Los Angeles-Long Beach-Glendale metropolitan area declined slightly to 1.3% share of negative equity, while San Francisco-Redwood City-South San Francisco metropolitan area remained level at  0.7%.

Up until the end of 2012, any decrease in underwater homes was mainly due to short sales and foreclosure sales. However, the price jump experienced in 2013, particularly in low-tier homes, is credited with pulling many homes into positive equity, accelerating the disappearance of underwater homeowners. This price increase has leveled out, as it was due primarily to speculator activity, which has substantially slowed down.

As of Q4 2019, the average California homeowner gained $8,000 in equity over the previous 12 months, a decrease from a year earlier when the average home gained $20,000 in equity over the course of a year. As price growth has leveled off going into 2020, expect the number of underwater homes to remain level in the coming months. These numbers will grow if home prices decrease in reaction to slowing sales. However, this dynamic is complicated by today’s historically low interest rates, which are increasing buyer purchasing power.

The rate of delinquencies, notices of default (NODs) and rising home prices are indicators of when underwater homes will disappear.

NODs, delinquencies at normal levels

An NOD is filed when a homeowner is three or more months delinquent on their mortgage payment.

California’s inventory of homes in foreclosure comprised just 0.5% of all mortgaged homes in the state in July 2015. However, as prices continue to falter in 2020, expect foreclosures and the resulting distressed sales to creep back up. By then, increased mortgage interest rates will have reduced purchasing power for long enough to push down home prices, increasing negative equity and thus driving a modest increase in foreclosures.

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These economic tenants will be unable to fully contribute to the state’s economy. An excessive portion of their income will go toward paying above-market interest rates on their mortgages. Significantly underwater homeowners make monthly mortgage payments greater than the rental value of the property.

That money is sucked into their black-hole asset, and removed from the economy. Instead of going towards goods and services, the money just makes Wall Street bond market investors richer.

Prices remain tenuous

Home price increases kept pace with inflation in 2019, an increase is markedly smaller than experienced anytime since 2012, and prices have fallen on a monthly basis since August 2018. Home prices may fall in 2020 in reaction to a drastically lower home sales volume. However, lower mortgage rates have given home prices a major boost in 2020, allowing homebuyers to qualify for higher principal amounts.

A sustainable rise in pricing will not occur until it can be supported by end user demand. In 2020, demand is hampered by stay-at-home orders to protect against the coronavirus (COVID-19) outbreak. Whether or not this will have a long-term impact on prices will depend on how long social distancing lasts. A few short months of sheltering in place will see home sales volume and prices bounce back quickly. However, anything longer than five or six months of frozen economic and homebuying activity may see the housing market slip into another depression.

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When will my home (and I) be solvent for good?

Underwater homeowners hoping for prices or amortization will make them solvent will eventually reach their goal. Of course, this will take roughly 10 to 15 years of paying into an underwater mortgage. Eventually, (around 2020 for underwater homeowners who purchased at the height of the Boom), their principal balance and home price crossed over for good. Then, for the first time, their mortgage payments are actually create positive equity. After 10 to 15 years, they’ll finally know the magic of amortization.

The wildcard in this timeline is asset inflation. Home pricing undulates around the historical mean price, at times above and at times below. During a mini-boom bounce, home prices may briefly carry some homeowners out of negative equity. 2021-2023 appears to be set as the next mini-boom on the horizon. Homeowners waiting for market momentum to create equity might sell then. For the stalwart others who continue to pay, see you in 2020 at the earliest.

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The mean price trendline: the home price anchor