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Nearly 40% Who Borrowed Against Homes Are Underwater

Almost 40% of homeowners who took out second mortgages—extracting cash from their residences to cover everything from vacations to medical bills—are underwater on their loans, more than twice the rate of owners who didn't take out such loans.

The finding, in a report released Tuesday by real-estate data firm CoreLogic Inc. (NYSE: CLGX - News), illustrates the consequences of easy borrowing amid the housing boom's inflated prices. The report says 38% of borrowers who took cash out of their residences using home-equity loans are underwater, or owe more than their home is worth. By contrast, 18% of borrowers who don't have these loans were underwater.

It's not clear how much cash withdrawn from homes during the boom was used to acquire luxuries such as expensive automobiles, and how much went to basic necessities, including tuition expenses, or renovations intended to raise a property's value.

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What is clear is that home-equity loans, which account for about 10% of the U.S. mortgage market, have been a headache for homeowners and lenders alike. Second mortgages refer to any loan taken out on a property that is subordinate to the first mortgage, and include home-equity loans or lines of credit.

Second mortgages are weighing on a fitful recovery, in which housing has figured as particularly weak spot. The S&P/Case-Shiller National Index last week showed that home prices tumbled 4.2% nationwide in the first quarter, its third straight quarter of price declines after a modest recovery in early 2010. Nationwide, prices have fallen 34% since their peak in 2006. The inventory of unsold homes will take 9.2 months to sell, the National Association of Realtors said recently, about 50% higher than what is considered a healthy level.

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"When a homeowner's house is underwater, "it's harder to get a credit card or a car loan, you can't put your home up for a small business loan," said Mark Zandi, chief economist at Moody's Analytics. "There are all sorts of little, pernicious effects that you don't necessarily think about."

CoreLogic found that borrowers with second mortgages had deeper levels of negative equity—an average of $83,000 compared with $52,000—than borrowers without second mortgages. In many cases, borrowers withdrew cash from their properties using home-equity loans or lines of credit, a type of second mortgage. The CoreLogic report doesn't include cash-out refinancing, a common practice during the boom, where borrowers opted to extract cash while refinancing their first mortgage.

According to Federal Reserve Board data, homeowners took out a total of $2.69 trillion from their homes at the height of the housing boom between 2004 and 2006. That tally includes cash-out refinancings.

[More from WSJ.com: When the Value of Housing Ruins the Home]

"Easy access to home equity loans during the housing boom put borrowers who extracted home equity at more risk," said Mark Fleming, CoreLogic's chief economist. "The price declines were felt more severely by people who took out home-equity loans."

Overall, the CoreLogic report found that the percentage of underwater homeowners declined slightly in the first quarter. About 10.9 million Americans who borrowed to buy their homes, or 22.7% of all homeowners with a mortgage nationwide, were underwater in the first quarter, down from 11.1 million, or 23.1%, in the fourth quarter of 2010.

The modest decline wasn't a sign of an improving market. Rather, the change reflected completed foreclosures, which reduced the total number of homeowners in the market, CoreLogic said.

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"The implication is that there are still a lot of people who are at risk of default, so delinquency and default rates are going to reflect that large amount of negative equity for some time to come," said Jan Hatzius, chief U.S. economist for Goldman Sachs Group.

The risks extend beyond the borrowers to banks. While the majority of first mortgages were bundled into pools and resold to investors as securities, second-lien mortgages are heavily concentrated on bank balance sheets.

Nearly three-quarters of roughly $950 billion in home-equity loans outstanding were held by commercial banks at the end of last year, according to Federal Reserve data. More than 40% of that debt is on the books of the nation's four largest banks: Wells Fargo & Co. (NYSE: WFC - News), Bank of America Corp. (NYSE: BAC - News), J.P. Morgan Chase & Co. (NYSE: JPM - News), and Citigroup Inc. (NYSE: C - News) Requiring big writedowns on those loans could burn through banks' capital.

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Second mortgages have made it more difficult for troubled borrowers to negotiate loan modifications with lenders. Economists say borrowers with second mortgages on homes that are underwater are far more likely to walk away from their homes.

Homeowners seeking a "short sale," in which they sell their property for less than the value of the outstanding mortgage, have a much harder time doing so when they have a second loan, because all the lenders involved must agree to take losses on the sale, and second-lien holders take the first losses in such a situation.

In 2005, Matt Facchini, took out a $200,000 home-equity loan on his home in Toms River, N.J., and used it to pay his divorce settlement, pay down some credit card debt and make home renovations, including installing new fences and restoring the swimming pool.

Two years ago, after price declines put him approximately $190,000 underwater, he walked away from the home, and is currently trying to negotiate a short sale. But Mr. Facchini, who works installing insulation for pipes, worries that the lender on his second mortgage will demand that he pay the approximately $70,000 deficiency on the second loan.

"I'm sweating. I have a broken car sitting in my driveway that I can't afford to fix. I can't get a loan to buy a new car because my credit is ruined," Mr. Facchini said. "I'm hoping they don't come after me for the money I owe them. That would be, for me, the end of it all."

Nevada, which has seen homes lose half their value on average in some markets, had the highest rate of negative equity, with 63% of its mortgaged properties underwater, followed by Arizona (50%), Florida (46%) and Michigan (36%). Two-thirds of homeowners with a mortgage in Las Vegas are underwater, while 56% of homeowners in Stockton, Calif., and 55% of Phoenix mortgage-borrowers have negative equity.

—Nick Timiraos contributed to this article.

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Renting’s financial edge over homeownership remains near historic lows, at least by one measurement.

When comparing local rents (using RealFacts statistics for large apartment complexes) and estimates of mortgage payments for Orange County homebuyers (from DataQuick) we find that rents ran at 39% less than house payments in the first quarter.

This ratio has been flat for three consecutive quarters and has been under 40% since the second quarter of 2009. Since 1988, rents have averaged 44 percent of mortgage payments. Rent’s financial edge hit a low — our data goes to 1988 — of 36% in the second half of 2009.

But comparing a $2,295 a month mortgage payment to a $1,406 monthly rent check — the first quarter results —  isn’t the entire story of whether one should buy a home.

Yes, this is simple math — for example, owners have other expenses — from taxes to maintenance — plus tax breaks on interest. And a house shopper would also have to come up with a downpayment to buy. And recent history tells you that ownership is no guarantee of keeping one’s investment in a home.

Yet this ratio tells the tale of local housing. Price drops on homes — and low interest rates — have helped narrow the rent-vs.-buy gap.

Homebuyers’ typical mortgage payments have fallen 35% since they peaked in the first quarter of 2007. Rents have softened, too, as landlords cut their prices as the recession forced some tenants to double up in various ways. Plus, the weak economy nudged more homes into the rental market, creating more competition. By our math, effective rents — what landlords get, asking rates times occupancy — are off 7 percent from their peak in the last quarter of 2008.

The narrow gap between renting and buying suggests that the housing market could have support for a rebound if other conditions improve. That’s a big caveat. A wobbly job market does not amp up consumer confidence needed to buy a home. Volatile home pricing has scared off some shoppers and banks have made it difficult for anyone but the highest-quality borrower to qualify for a mortgage.
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WHY A VA LOAN? 

The more you know about our home loan program, the more you will realize how little "red tape" there really is in getting a VA loan. These loans are often made without any downpayment at all. Aside from the veteran's certificate of eligibility and the fact that the appraiser is assigned by VA, the application process is not much different than any other type of mortgage loan. And if the lender is approved for automatic processing and the Lender Appraisal Processing Program (LAPP), as more and more lenders are now, a buyer's loan can be processed and closed by the lender without waiting for VA's approval of the credit application or for VA to review the appraisal.

Lenders are also able to use VA recognized automated underwriting systems, such as Loan Prospector and Desktop Underwriter, to facilitate the underwriting process.

FIVE EASY STEPS TO A VA LOAN

1.  Apply for a Certificate of Eligibility (COE).

While several options exist to obtain a COE, we certainly encourage Veterans to receive their COE online at: http://www.ebenefits.va.gov/.  Once at the eBenefits portal, click the My eBenefits tab towards the top, on the left side, which will open a page with several benefit areas.  On the bottom right of the screen is the Housing tab.  You will need login credentials to request a Certificate of Eligibility (COE).  If you already have them, enter your Username and Password, if you need to request login credentials, you can simply click on the "Request/Activate a DoD Self-Service Logon" link which is shown below the area where you logon.

Alternatively, Veterans can obtain their COE by completing VA Form 26-1880, Request for a Certificate of Eligibility, and mailing it, along with proof of military service, to the Eligibility Center (you will find the Eligibility Center’s address on VA Form 26-1880). Also, Veterans who have already begun the loan application process with a lender may request the lender’s assistance obtaining a COE.

2.  Decide on a home to buy and sign a purchase agreement.
 
3.  Order an appraisal from VA. (Usually this is done by the lender.)

Ordering an appraisal can be done via the Internet using TAS (The Appraisal System). This is a centralized system that allows lenders easy and quick access to order an appraisal.

4.  Apply to a mortgage lender for the loan.

While the appraisal is being done, the lender can be gathering credit and income information. If the lender is authorized by VA to process loans on the automatic basis (and approx. 99 percent of all VA loans are processed this way), the loan can be approved and closed upon receipt of the appraised value determination without waiting for a VA review of the credit application. VA has also approved the use of several automated underwriting systems for lenders to use in connection with VA loans. The two main systems are Loan Prospector and Desktop Underwriter. For loans that must be approved by VA, lenders send the credit package to VA. VA staff will then review it and notify the lender of the decision.

5.  Close the loan and move in.

VA FINANCING - A GOOD DEAL FOR VETERANS

More than 27 million veterans and service personnel are eligible for VA financing. Even though many veterans have already used their loan benefits, it may be possible for them to buy homes again with VA financing using remaining or restored loan entitlement.

Before arranging for a new mortgage to finance a home purchase, veterans should consider some of the advantages of VA home loans:

• Most important consideration, no downpayment is required in most cases.
• Loan maximum may be up to 100 percent of the VA-established reasonable value of the property. Due to secondary market requirements, however, loans generally may not exceed $417,000 ($625,500 for loans in Hawaii, Alaska, Guam and U.S. Virgin Islands). This figure is subject to change each year.
• Flexibility of negotiating interest rates with the lender.
• No monthly mortgage insurance premium to pay.
• Limitation on buyer's closing costs.
• An appraisal, which informs the buyer of estimated property value.
• Thirty-year loans with a choice of repayment plans.
• Traditional fixed payment: (constant principal and interest: increases or decreases may be expected in property taxes and homeowner's insurance coverage); Graduated Payment Mortgage-GPM (low initial payments which gradually rise to a level payment starting in the sixth year); and in some areas, Growing Equity Mortgages-GEMs (gradually increasing payments with all of the increase applied to principal, resulting in an early payoff of the loan). Hybrid ARMs: VA is authorized to guarantee hybrid ARM loans where the initial rate remains fixed for at least 3 years. The initial adjustment can be as much as 2 percent if the fixed rate period is 5 or more years. Annual adjustments thereafter are limited to 1 percent if the fixed rate period is less than 5 years, and 2 percent if the fixed rate period is 5 or more years. If the fixed rate period is less than 5 years, the initial adjustment is limited to 1 percent and the annual cap to 5 percentage points. Traditional ARM loans: VA can also guarantee traditional 1-year ARM loans where the rate is adjusted annually. Annual adjustments are limited to 1 percent and the maximum interest rate increase over the life of the loan is limited to 5 percentage points.
• New homes, which are appraised before or during construction, are inspected to help ensure compliance with the plans and specifications used for the appraisal and with VA minimum property requirements. All new houses, regardless of when appraised, are covered by either a 1-year builder's warranty or a 10-year insured protection plan.
• An assumable mortgage, subject to VA approval of the assumer's credit.
• Right to prepay loan without penalty.
• VA performs personal loan servicing and offers financial counseling to help veterans avoid losing their homes during temporary financial difficulties.

WHAT IS A VA-GUARANTEED LOAN?

These loans are made by a lender, such as a mortgage company, savings and loan, or bank. VA's guaranty on the loan protects the lender against loss if the payments are not made, and is intended to encourage lenders to offer veterans loans with more favorable terms. The amount of guaranty on the loan depends on the loan amount and whether the veteran used some entitlement previously. With the current maximum guaranty, a veteran who hasn't previously used the benefit may be able to obtain a VA loan up to $417,000 ($625,500 for loans in Hawaii, Alaska, Guam and U.S. Virgin Islands), depending on the borrower's income level and the appraised value of the property. Your VA Regional Loan Center can provide more details on guaranty and entitlement amounts.

WHAT CAN A VA LOAN BE USED FOR?

• To buy a home, a condominium unit in a VA-approved project, or to purchase a unit in a cooperative (co-op).
• To build a home.
• To simultaneously purchase and improve a home.
• To improve a home by installing energy-related features such as solar or heating/cooling systems, water heaters, insulation, weather-stripping/caulking, storm windows/doors, or other energy efficient improvements approved by the lender and VA. These features may be added to the purchase of an existing dwelling or by refinancing a home owned and occupied by the veteran. A loan can be increased up to $3,000 based on documented costs or up to $6,000 if the increase in the mortgage payment is offset by the expected reduction in utility costs. A refinancing loan may not exceed 90 percent of the appraised value plus the costs of the improvements. Check with a lender or VA for details.
• To refinance an existing home loan up to 90 percent of the VA-established reasonable value or to refinance an existing VA loan to reduce the interest rate.
• To buy a manufactured home and/or lot.

WHO IS ELIGIBLE? 

Veterans with active duty service, that was not dishonorable, during World War II and later periods, are eligible for VA loan benefits. World War II (September 16, 1940 to July 25, 1947), Korean conflict (June 27, 1950 to January 31, 1955), and Vietnam era (August 5, 1964 to May 7, 1975) veterans must have at least 90 days of service. Veterans with service only during peacetime periods and active duty military personnel must have had more than 180 days of active service. Veterans of enlisted service which began after September 7, 1980, or officers with service beginning after October 16,1981, must in most cases have served at least 2 years.

Gulf War. Basically, reservists and National Guard members who were activated on or after August 2, 1990, served at least 90 days and were discharged honorably, are eligible. VA can assist with eligibility questions.

Members of the Selected Reserve, including National Guard, who are not otherwise eligible and who have completed 6 years of service and have been honorably discharged or have completed 6 years of service and are still serving, may be eligible. Contact the VA Eligibility Center to find out what is needed to establish eligibility. Reservists will pay a slightly higher funding fee than regular veterans. (See paragraph entitled "Costs of Obtaining a VA Loan.")

HAD A VA LOAN BEFORE? 

Remaining Entitlement 

Veterans who had a VA loan before may still have "remaining entitlement" to use for another VA loan. The current amount of entitlement available to each eligible veteran is $36,000. This was much lower in years past and has been increased over time by changes in the law. For example, a veteran who obtained a $25,000 loan in 1974 would have used $12,500 guaranty entitlement, the maximum then available. Even if that loan is not paid off, the veteran could use the $23,500 difference between the $12,500 entitlement originally used and the current maximum of $36,000 to buy another home with VA financing. For certain loans in excess of $144,000, the basic $36,000 entitlement can be increased to a maximum guaranty equal to 25 percent of the Freddie Mac conforming loan limit for a single family residence, minus any previously used entitlement.

Most lenders require that a combination of the guaranty entitlement and any cash downpayment must equal at least 25 percent of the reasonable value or sales price of the property, whichever is less. Thus, in the example, the veteran's $23,500 remaining entitlement would probably meet a lender's minimum guaranty requirement for a no-downpayment loan to buy a property valued at and selling for $94,000. The veteran could also combine a downpayment with the remaining entitlement for a larger loan amount.

Restoration of Entitlement 

Veterans can have previously-used entitlement "restored" to purchase another home with a VA loan if:

• The property purchased with the prior VA loan has been sold and the loan paid in full, or
• A qualified veteran-transferee (buyer) agrees to assume the VA loan and substitute his or her entitlement for the same amount of entitlement originally used by the veteran seller. The entitlement may also be restored one time only if the veteran has repaid the prior VA loan in full, but has not disposed of the property purchased with the prior VA loan. Remaining entitlement and restoration of entitlement can be requested through the VA Eligibility Center by completing VA Form 26-1880.

HOW TO GET A VA LOAN 

VA Appraisal 

Because the loan amount may not exceed VA's estimate of the value of the property, the first step in getting a VA loan is usually to request an appraisal. Although anyone (buyer, seller, real estate personnel or lender) can request a VA appraisal, usually this is done by the lender via the Internet using TAS (The Appraisal System). The appraiser will send a bill for his or her services to the requester according to a fee schedule approved by VA. To simplify things, VA and HUD/FHA (Department of Housing and Urban Development/Federal Housing Administration) generally use the same appraisal forms.

It is important to recognize that while the VA appraisal estimates the value of the property, it is not an inspection and does not guarantee that the house is free of defects. Homebuyers should be encouraged to carefully inspect the property themselves, or to hire a reputable inspection firm to help in this area. VA guarantees the loan, not the condition of the property.

Application 

The application process for VA financing is no different from any other type of loan. In fact, the VA application form is the same as that used for HUD/FHA and conventional loans. The mortgage lender verifies the applicant's income and assets, and obtains a credit report to see that other obligations are being paid on time. If all is well and the appraised value of the property is enough to cover the loan needed, the lender, in most instances, can then close the loan under VA's automatic procedure. Only about 1 percent of VA loan applications have to be submitted to a VA office for approval before closing.

REQUIREMENTS FOR LOAN APPROVAL 

To obtain a VA loan, the law requires that:

• The applicant must be an eligible veteran who has available entitlement.
• The loan must be for an eligible purpose.
• The veteran must occupy or intend to occupy the property as a home within a reasonable period of time after closing the loan.
• The veteran must be a satisfactory credit risk.
• The income of the veteran and spouse, if any, must be shown to be stable and sufficient to meet the mortgage payments, cover the costs of owning a home, take care of other obligations and expenses, and have enough left over for family support. An experienced mortgage lender will be able to discuss specific income and other qualifying requirements.

COSTS OF OBTAINING A VA LOAN

Funding Fee

• A funding fee must be paid by all veterans using the VA home loan program, except those exempt due to receipt of disability compensation.
• The funding fee can range from 0.5 percent for Interest Rate Reduction Refinancing Loans (IRRRLs) to 3.3 percent for veterans who are subsequent users of the VA home loan program.
• For all VA loans, the funding fee may be paid in cash or included in the loan.
• For more information on the VA funding fee, contact your VA Regional Loan Center.

Other Closing Costs

Reasonable closing costs may be charged by the lender. These costs may not be included in the loan. The following items may be paid by the veteran purchaser, the seller, or shared. Closing costs may vary among lenders and also throughout the nation because of differing local laws and customs.

• VA appraisal
• Credit report
• Loan origination fee (usually 1 percent of the loan)
• Discount points
• Title search and title insurance
• Recording fees
• State and/or local transfer taxes, if applicable
• Survey

No commissions, brokerage fees, or "buyer broker" fees may be charged to the veteran buyer.

Q.  I am a 43-year-old looking to buy a home in Costa Mesa. My salary is $125,000 and I will get government pension when I retire. I just began making decent money about five years ago. I have student loans ($40,000) and very Little savings.  The banks for some odd reason will loan me upwards of $500,000 on an FHA loan. I could come up with most of the down payment for a house, borrowing against a 403b plan (a government version of 401(k)). It will take me about 7 to 10 years to save for a 20 percent down payment.  Should I wait or give up and be a lifelong renter?

A. With all that has happened in the housing market, I can understand your hesitancy but I think that this is the best time in the last 30 years to be a buyer. With prices and interest rates both low, it makes housing more affordable than in a long time.

So I would proceed with enthusiasm, but don’t let someone lend you too much money, just because you qualify for it. Don’t do anything that isn’t comfortable.  Set up the withdrawal from your 403(b) so you are ready when you need it. Calculate what payment you need to make to pay the loan off the year you retire.

Also, the Mutual Mortgage Insurance premium on FHA loans is very high, and I would make additional payments on the mortgage so as to bring down the principal balance to 80 percent loan to value.  If rates are still low then, you can refinance into a conventional mortgage without the MMI payment.

Finally, I think it is important that you establish some financial goals and do some serious budgeting. Someone with your income should be setting aside 25 percent of your income in some kind of wealth-building program, whether it’s accumulating assets or paying off debt or both.

Q. With the foreclosures happening all over the United States, we were thinking of trying to pick up a condo in another state where we often vacation. Our hope is to pick up a small two-bedroom condo at a great deal.  We’ve heard that you can use IRA money to fund a purchase of a home/condo.  Is this option only available for monies in a Roth IRA?  Are there tax implications?  What traps should we be looking out for in purchasing a foreclosed or auctioned condo?

A. Even if your plan administrator says you can use the IRA for something other than a principal residence, I would be very reluctant to advise you to raid a retirement program to fund what is basically a speculative venture. Look at the name on the accounts: Individual RETIREMENT Account. That’s what it is for.  You can rent a very nice room at a resort for a week almost anywhere these days and have your vacation that way.

The exception to this is if it is a potential retirement home, but even there I would proceed with great caution. The farther your property is from home, the less you know about that market and those properties. It’s harder to get to and harder it is to manage.

If you want to buy another property, save money separately for a dow payment and then move very, very cautiously.  This is a path fraught with dangers you cannot imagine.

Until I’m back on site, mellowing on the grass as waves crash nearby, I tend to forget that there’s no weekend bash in O.C. (maybe L.A. too) that better embodies the spirit of Monterey Pop than the annual Doheny Blues Festival in Dana Point.

Not only are the crowds laid-back, highly attentive and deeply into the sounds, but the performers — who this time range from gospel great Mavis Staples and New Orleans funk pioneers the Funky Meters to a fest-closing set Sunday evening from John Fogerty, with a dozen more in between — all evoke the soul-satisfying musical purity that rose out of the late ’60s.

And no act did that more during Saturday’s half of the festival than the touring Experience Hendrix troupe, an all-star array of modern and legendary guitar greats in a nearly three-hour tribute to the most innovative virtuoso who ever touched six strings. It’s the first time the concept has come to Orange County, but I daresay there was a sparked-up feel to this outdoor set that earlier appearances indoors at Gibson Amphitheatre couldn’t possibly capture. At Doheny, it felt a bit like Clapton’s Crossroads Festival had been miniaturized and shipped west.

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