From Underwater to ‘Equity Poor’: Why the Housing Market Isn’t Recovering Faster

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Rates are at historic lows of 3.53% for 30-year mortgages. Rents are at record levels all over the country, hitting highs in 74 markets tracked by real-estate-data provider Reis Inc. And housing prices appear to have finally begun increasing, with gains posted for three months in a row according to the index put out by the Federal Housing Finance Agency. So why aren’t more Americans buying houses?

The answer to that is rather complex, but one major factor is that trade-up buyers — folks who upgrade from smaller, cheaper “starter homes” to pricier properties, and who classically are a pumping piston in the engine that drives the housing market — are finding it difficult, if not impossible, to trade up right now. This key segment of the market is especially likely to be “equity poor.”

Unlike underwater borrowers — who have negative equity, with more debt on their homes than those homes are worth — equity-poor borrowers have less than 20% equity in their homes. Why 20%? In the current tight lending climate, buyers generally need to put 20% down on a home in order to get a mortgage. So if you’re currently in a $400,000 home, even if you have 20% equity, you can’t trade up to buying a $600,000 home solely on the basis of the money you would extract if you sold.

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According to CoreLogic, a real-estate-data provider based in Santa Ana, Calif., roughly 45% of homeowners with mortgages have less than 20% equity in their homes. This tally includes owners who are underwater. Approximately one-quarter of this group can be described as equity poor. In other words, more than 11 million households have some equity, but not more than 20%, and they are not far enough up the ladder to easily attempt a jump up to the next rung.

What’s interesting (and unfortunate) about the equity-poor populace is that even as the real estate market appears to be recovering, this segment continues to be stuck. Underwater borrowers, by contrast, are seeing recovery. Some 700,000 homeowners who had been underwater in the last quarter of 2011 climbed into the black in the first quarter of this year, with the negative-equity segment dropping from 25.2% of all homeowners with mortgages to just 23.7%.

In part, that’s because a lot of the underwater homeowners tend to be in cheap houses, or in states with a great many distressed houses, and as cash investors vacuum up those particular types of homes, the prices in their market segments rise dramatically. Equity-poor homeowners, by contrast, are more likely to be spread throughout different states and different price points of homeownership, so the jump in prices in cheap houses in Vegas doesn’t necessarily translate to helping them.

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As underwater homeowners cross the threshold out of negative equity, they immediately can be categorized as equity poor, with somewhere between 0% and 20% equity in their homes. There’s a symbiotic relationship between the two categories, with the equity-poor segment rising as the number of underwater homeowners shrinks.

Even so, right now, states with an unusually large percentage of equity-poor homeowners include Oklahoma, Nebraska, Tennessee, North Carolina and Arkansas — a far cry from the usual suspects in the foreclosure crisis, which are Arizona, Nevada, Florida, California and Michigan. (Though prices in many parts of Nevada are recovering, as of the first quarter, it still wins the title of most distressed state, with 61% of all of its mortgaged properties underwater.)

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So what should you do if you’re equity poor? First, be happy you’re not underwater. Next, probably the most prudent course is to do what the majority of Americans are doing: not much of anything. Sit tight, try to be patient — and take advantage of today’s low mortgage rates with a refinancing, if you possibly can.

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