Last year was an eventful one for the U.S. housing market. Mortgage interest rates increased at the fastest pace since the 1980s. Home price growth matched that of 2021 but most of the acceleration occurred in the first quarter of the year. The latter half of 2022 was marked by home price declines along with an overall rebalancing of homebuyer and seller advantages and expectations.
In addition to the many changes seen in the housing market, U.S. consumers are contending with a much-anticipated economic recession in 2023. Although there is much debate on the relative softness or hardness of the landing given the Federal Reserve’s aggressive monetary tightening policies, existing homeowners are better prepared for whatever the 2023 economy ends up looking like. One important difference in this real estate slowdown is the amount of home equity that existing homeowners have, which will help many in cases of financial distress.
According to a recent CoreLogic report, homeowner equity has been on the rise since the Great Recession, when home prices last declined. The aggregate value of this net equity has grown from about $3.5 trillion at the start of 2010 to nearly $16 trillion as of third-quarter 2022. Across all homes with a mortgage, the average equity per borrower now amounts to roughly $284,000. In 2010, the average borrower had $75,000 in equity. Loan-to-value (LTV) ratio is another way to look at this: The accumulation of homeowner equity has notably reduced the average LTV since the prior recession — from about 71% in Q1 2010 to less than 44% in Q3 2022.
While solid loan underwriting standards (including 20% downpayments) have helped to lower LTVs, there are several other reasons for the stronger homeowner positions in the current housing cycle. Recent surges in home prices have been a significant contributor to home equity accumulation. In the two-year period from the onset of the COVID-19 pandemic until this past summer, cumulative home price growth reached nearly 40% nationwide.
In some markets, this cumulative growth has been even steeper, which also means that the equity per mortgaged home greatly exceeds the national average of $284,000. For instance, this figure stood at nearly $550,000 for homes in California and $430,000 for homes in Washington state as of Q3 2022.
Nevertheless, after peaking this past June, U.S. home prices declined by 2% by October. With concerns of deeper and more widespread price declines, it is natural to worry that this will impact recent homebuyers, particularly those who could not afford to put down 20% and/or purchased a home at the peak of the market (i.e., in the spring of 2022).
Lower home prices have already led to an increase in the number of homes with negative equity (those with LTVs of 100% of more). Some 43,000 additional properties fell into this category between the second and third quarters of last year, bringing the total number of underwater properties to about 1.09 million (or 1.9% of all mortgaged homes). But there were about 1.21 million such homes in Q3 2021, representing 2.2% of homes with mortgages.
Again, this recent increase is a function of falling prices. During the Great Recession, more than 12 million properties (or 26% of mortgaged properties) were underwater. Today, while home prices have yet to find a floor and will likely continue to decline in some markets, most experts do not expect a home price correction at the magnitude seen more than a decade ago.
According to CoreLogic’s December 2022 home price index forecast, extremely low for-sale inventory and mortgage rate improvements will help prop up prices in 2023. But if you’re wondering what the worst-case scenario is, prices would need to drop by 40% to 45% from their recent peak for the negative-equity share to reach 26% again — an unlikely scenario. ●
