Zillow Reports that 21% of Homeowners are Underwater
Zillow reported last month that 21% of homeowners have mortgage balances in excess of their market values. This was widely cited as another spike in the coffin of the real estate market. I suppose it's true that homeowners in this position are more prone to foreclosure and loan default than homeowners with positive equity. If you get into financial difficulty, you can't sell your house to get out of trouble without paying out cash at closing (which you presumably don't have if you are having financial difficulties). Refinancing is creates the same problem - you can't refinance your home for the existing mortgage amount because the home will not appraise for the loan amount.
However, the foreclosure rate is tiny - only .1 of 1% of all homes nationally faced foreclosure in 2009. If they all came from this underwater group, then only .5% of the group gets foreclosed every year. I think the negative effects of foreclosures are more than offset by something even more powerful.
I think a larger impact and certainly a more positive one is that this underwater situation will keep a huge chunk of the national real estate supply off the market for years. Clearly, most of the people in this group are capable of making their mortgage payments and have no intention of losing their home to foreclosure. But many will be unable or unwilling to sell their home due to the large cash requirement to do so.
The impact will likely be the long-term removal of homes from the market and stable prices. It is already happening (the inventory removal anyway). The huge drop in inventory since 2007 is mostly due to people taking homes off the market.