Declining home prices in the latter part of 2010 drove more borrowers underwater on their mortgages, according to business service analytics firm CoreLogic. The portion of residential mortgages in negative equity at the end of the fourth quarter was 23.1%, up from 22.5% in the third quarter. That means nearly one-quarter of Americans with mortgages have balances that exceed the value of their home. The report provides a grim status update on the housing market.

First, let's talk numbers. The 23.1% of underwater borrowers represents 11.1 million homeowners. CoreLogic also identifies that another 5.0%, or 2.4 million, borrowers are "near negative equity" mortgages, having equity of less than 5%. The firm further estimates that if home prices decline another 5% to 10% in 2011, which is in line with the consensus expectations, then the portion of underwater mortgages could increase by as much as 10%. That would put roughly one-third of American mortgages underwater.

In terms of dollar values, of the $12.5 trillion in residential property value backed by mortgages, $8.8 trillion is outstanding and $3.7 trillion is equity. Put another way, of the residential property backed by mortgages in the U.S., Americans only own 30% of their homes. That's not a very impressive portion of equity: it indicates that these Americans, on a whole, own less than one-third of their homes. But it should be noted that these numbers do not take into account Americans who have paid off their mortgages and fully own their homes.

Now let's look at some charts provided by CoreLogic. Of the 28.1% of underwater and nearly underwater borrowers, here's how they break down in terms of severity of situation:

CoreLogic equity distribution 2010-q4.png

As you can see, negative equity is strongly skewed to Americans who are very far underwater. The portion of borrowers whose mortgages are 25% or more negative equity rose in the fourth quarter, after declining slightly in the third quarter. This news might not be as bad as you think: the reason why negative equity declined in the third quarter was due in large part to more foreclosures erasing negative equity balances. Since foreclosures slowed down in the fourth quarter while prices declined, it makes sense that negative equity increased across-the-board, as shown.

The breakdown in the hardest hit states is also striking. Here's another chart from CoreLogic:

CoreLogic worst-hit dist 2010-q4.png

This chart shows how awful housing markets are in these five states. In Nevada, home prices have declined so deeply that even after its many foreclosures, nearly 50% of homes have at least 25% negative equity. CoreLogic also reports that 65.4% of residential mortgages in Nevada are underwater. As shown, the portion of mortgages with at least 25% negative equity ticked up in Arizona, Florida, and California in the fourth quarter.

CoreLogic further reports that the aggregate level of negative equity increased to $751 billion in the fourth quarter, up from $744 billion in the third quarter. Here's another chart from CoreLogic showing how that breaks down in terms of severity:

CoreLogic neg equity seg 2010-q4.png

This chart shows pretty clearly that mortgages the deepest underwater are also responsible for most of the negative equity in the U.S. Homes more with than 50% negative equity are responsible for more than $450 billion -- more than half -- of the entire balance of negative equity. This casts doubt on the idea that mild principal reduction-driven mortgage modifications can solve the underwater mortgage problem. Deep losses would have to be realized on these severely underwater properties to get their mortgage balances even near the value of their home.

The CoreLogic report paints a pretty ugly picture of the housing market. Even when foreclosures and delinquencies begin to meaningfully decline, mortgage borrowers will be left in a deep hole. The idea that approximately one-quarter of Americans with mortgages would have to make $751 billion in principal payments -- which will be just a small fraction of their overall mortgage payments -- before they even begin to build equity is a very troubling realization.

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