1 million homeowners emerge from underwater in 3Q

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A sold sign in front of a home in San Francisco.

Nearly a million U.S. homeowners came up from underwater on their home loans in the third quarter, finally owing less than their homes are worth.

The nation's overall negative home equity rate fell to 13.4 percent of homeowners with a mortgage, down a full percentage point from the second quarter and from 16.9 percent a year ago, according to Zillow, the Seattle-based real estate firm. Historically, the typical negative equity rate is lower than 5 percent.

Fast-rising home prices are behind the gains. Home value gains widened in October, up 6.8 percent from October 2014. The gains had been contracting in the first half of this year. Recent price gains have reduced negative equity by a collective $60 billion in just three months. While the increase in home equity is sizable and the improvement since the worst of the housing crash dramatic, the negative equity crisis is far from over. More borrowers will now be able to refinance, but an inordinately large number are still stuck in place.

"Negative equity has become almost an afterthought in a handful of the nation's hottest markets, but is holding back the recovery in dozens of large markets nationwide," said Zillow Chief Economist Svenja Gudell.

Eight years after the housing crash began, more than 6.5 million homeowners are still underwater on their loans, and 30 percent of homeowners with a mortgage are still in an "effective" negative equity position; that means they don't have enough equity in their homes to afford a down payment on the next home or to afford the costs associated with selling and moving.

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All real estate is, of course, local, and some markets are drowning far more than others. The effective negative equity rates in Las Vegas (41.3 percent), Kansas City (38.1 percent) and Atlanta (37.9 percent) far exceed the national average. Even San Francisco and San Jose, two of the hottest housing markets in the nation, have effective negative equity rates of 7.7 percent and 11 percent respectively, according to Zillow.

Housing markets with higher rates of negative equity will have fewer homes for sale, as homeowners are stuck in place. Negative equity is concentrated in lower-priced homes, so this especially hurts the first-time buyer looking to purchase those homes. The supply of homes for sale is very tight nationwide, but it is especially tight at the entry level.

"Those homes that are available are often not in demand and stay on the market for a long time. This can be extremely frustrating for buyers and sellers alike, as they come face to face with the difficult side effects of negative equity," said Gudell.

The number of repeat buyers has dropped dramatically in the last decade, owing to negative equity, but when combined with tighter underwriting standards, the options for these buyers is even worse. Lenders today require higher levels of income compared to debt, and Americans in mid-tier FICO credit ranges have had increasing difficulty qualifying for loans.

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"National debt relative to disposable income for single-family mortgages is still high compared to historical levels, according to a new report from mortgage financing giant Fannie Mae. "These all point to increased challenges facing current homeowners."

Fannie Mae looked at homeowners in 2002 and found that they tended to trade up to another home earlier in life, generally in their 30s. Today that trade-up buyer distribution has shifted toward older generations, homeowners in their 50s and up.

While all eyes are on the Federal Reserve and a potential increase in interest rates in two weeks, the biggest hurdle facing a broader housing recovery is simply lack of homes for sale. Current homeowners are stuck in place, some due to lack of home equity, some due to such favorably priced long-term loans that moving isn't financially enticing. Inventory continues to fall, and real estate agents are already voicing concern that the 2016 spring market will suffer. Home prices are rising because of tight supply, not strong demand. Home equity is returning, but at a steep price to the health of the overall housing market.