Home Prices Rise But ‘Underwater’ Mortgages Could Have Negative Impact

Home prices crept up in September, rising 3.1% compared with three months earlier, Case-Shiller reports.

However, housing prices are still down 9% compared with a year ago, and there are storm clouds gathering, threatening America’s budding housing recovery.

First American Core Logic just released numbers showing that nearly one-quarter of all homeowners are underwater on their mortgage – virtually guaranteeing homeowners will walk away from those loans if they are unable to pay them back.

Some underwater homeowners are walking away from mortgage payments they can afford, rather than continue to lose money on a house that is worth less than the original asking price.

Many experts are calling this an ominous sign, despite the increase in home prices. “Things are going to cool off, the economy is still weak, this tax credit surge is kind of done, the foreclosure situation is getting worse by the day,” Christopher Thornberg, of Beacon Economics, recently told the LA Times.

Strengthening this view, the Mortgage Bankers Association of America reports that refinance applications dropped 1.4%, mortgage loan applications dropped 2.5%, and purchase applications dropped 4.5% in only the past week. It certainly appears that the surge created due to the tax credit deadline – since extended – is about to end.

For a silver lining, the majority of upside-down mortgages are concentrated in only five states. California, Florida, Arizona and Michigan are all between 35% and 48% underwater. Nevada boasts an alarming 65% of mortgages currently upside down. While these are crisis numbers for those five, the remaining 90% of states face a far rosier picture.

However, even in states with healthier housing markets, mortgages may be difficult to come by. Banks are continuing to cut back on lending, with no end in sight.

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“The choice for banks is very stark,” Brian Olasov, managing director of real estate law firm McKenna Long & Aldridge, told CNNMoney. “You can either repair your balance sheet or you can build your loan portfolio, but you can’t do both at the same time.”

With banks doubling the number of uncollectible mortgage loans reported in the past year, balance sheets remain far from healthy. Consequently, purchases of relatively safe Treasuries soared 49% in the last quarter. Asset-backed securitized loans continue to fall off a cliff, down to $118 billion so far this year, from $753 billion in 2006.

With so many homes underwater, many home loans resetting over the next two years, and banks continuing to back away from new mortgage loans, the modest rise in housing prices is likely to be short-lived.