One in 12 purchase mortgages originated in 2022 is now underwater, as the downturn in home prices over the past few months has opened the door to a slowly emerging but potentially problematic issue, Black Knight found.
Home prices fell for the fourth consecutive month in October, according to the data and business intelligence provider’s Mortgage Monitor report, dropping 0.43% from September on an unadjusted basis. The number represents the smallest monthly pullback since prices hit their peak in June, but the four-month long trend points to a growing loss in home equity that hits buyers who made purchases when costs were at their highest especially hard.
“Make no mistake: negative equity rates continue to run far below historical averages, but a clear bifurcation of risk has emerged between mortgaged homes purchased relatively recently versus those bought early in or before the pandemic,” said Ben Graboske, Black Knight Data & Analytics president, in a press release.
Of the 450,000 mortgages where the amount owed exceeded the value of the home at the end of the third quarter, almost 60% were originated this year, with purchases accounting for 95% of those. The percentage reflects a total of more than 250,000 underwater borrowers, while close to another million now have less than 10% equity in their properties, the report said.
Among borrowers with Federal Housing Administration-guaranteed mortgages, the numbers looked even starker. More than 25% of purchases made with FHA loans this year are now underwater, and two-thirds have less than 10% equity.
“This is an illustrative and, unfortunately, potentially vulnerable cohort that we will continue to keep a close eye on in the months ahead,” Graboske said. Early-stage delinquency rates tracking late payments for FHA-backed mortgages originated within the last six months have also surpassed their pre-pandemic levels, according to Black Knight’s data.
In total, 5% of all mortgage originations this year, including both purchases and refinances, are currently underwater. Since its nationwide peak in June, the median U.S. home price has fallen 3.2%. But risk for purchases made before this year is “essentially nonexistent” due to the large equity cushions those mortgage holders currently have, Graboske added.
But the drop in prices is not the only cause of the increase in underwater mortgages, with a range in variability throughout the country. San Jose, California, where many buyers might put large down payments on jumbo mortgages, saw only 2.4% of loans underwater, even as the region saw one of the steepest price declines from its peak this year. Meanwhile, markets with a greater percentage of high loan-to-value ratio loans, such as Honolulu and Colorado Springs, Colorado, both recorded their share of underwater homes above 30%.
On a year-over-year basis, home prices in October still came in 9.3% higher, but slowed from a 10.6% annual pace of appreciation in September. The 1.3% monthly drop in the margin of price appreciation was the smallest since May, but October’s annual price growth was still the slowest in more than two years.
The market might normally see a sharper contraction in property values and appreciation under the type of affordability and interest rate conditions it faces, according to Graboske, but a still-small supply of for-sale homes has prevented prices from falling to a more affordable level.
“Though seemingly counterintuitive, the much higher rate environment may be limiting the pace of price corrections due to its dampening effect on inventory inflow and subsequent gridlock in home sale activity,” he said. “One might expect a far steeper correction in prices than we have endured so far, but the never-ending inventory shortage has served to counterbalance these other factors.”
The volume of new for-sale listings in October came in 19% below the 2017-to-2019 pre-pandemic average, the largest deficit in six years, excluding early pandemic months, as 30-year benchmark interest rates briefly surpassed 7% that month.