The downturn in home prices has left about 20% of U.S. homeowners owing more on a mortgage than their homes are worth, according to one new study, signaling additional challenges to the Obama administration's efforts to stabilize the housing market.

The increase in the number of such "underwater" borrowers comes amid signs that falling prices are making homes more affordable for first-time buyers and others who have been shut out of the housing market. But falling prices also make it more difficult for homeowners who get into financial trouble to refinance or sell their homes, and for others to take advantage of lower interest rates.

For instance, fewer will qualify to take advantage of a key component of the Obama administration's plan to stabilize the housing market. Under the plan, announced in February, as many as five million homeowners whose loans are owned or guaranteed by government-controlled mortgage giants Fannie Mae and Freddie Mac can refinance their mortgages, but only if the mortgage loan is a maximum of 105% of the home's value.

Real-estate Web site Zillow.com said that overall, the number of borrowers who are underwater climbed to 20.4 million at the end of the first quarter from 16.3 million at the end of the fourth quarter. The latest figure represents 21.9% of all homeowners, according to Zillow, up from 17.6% in the fourth quarter and 14.3% in the third quarter.

"What's going on here is that you don't have any markets that have turned around and you have new markets, like Dallas, that have joined the ranks" of communities where home prices have fallen, said Stan Humphries, a Zillow.com vice president.

Borrowers who owe far more than their home is worth may also be less likely to participate in another part of the government's housing plan, which provides incentives for mortgage companies to modify loans to make payments more affordable. Thomas Lawler, an independent housing economist, said borrowers who owe 30% more than their homes are worth are far more likely to walk away from their property than those who owe just 5% or 10% more and expect prices to rebound. More than one in 10 borrowers with a mortgage owed 110% or more of their home's value at the end of last year, according to First American CoreLogic.

There are some recent indications that the housing market could be beginning to stabilize. The National Association of Realtors pending home-sales index, for instance, increased 3.2% in March.

Just how many borrowers are underwater is a matter of some dispute, with the answer depending in part on assumptions regarding home values and mortgage debt outstanding. Variations in home-price estimates can make a major difference in the number of borrowers who are underwater. In addition, borrowers who are already in the foreclosure process may be counted as being underwater if the title to their property hasn't changed hands.

Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley, said underwater estimates can be too high if they use price data that includes a large number of foreclosures. Foreclosed homes tend to sell at a discount, he said, making it appear that prices have fallen more than they actually have.

Moody's Economy.com estimates that of 78.2 million owner-occupied single-family homes, 14.8 million borrowers, or 19%, owed more than their homes were worth at the end of the first quarter, up from 13.6 million at the end of last year.

Part of the reason Zillow's numbers are higher may be that it looks at mortgage debt taken out at the time the home was purchased and doesn't adjust for any payments since made toward the outstanding mortgage balance. It also assumes that borrowers who took out home-equity lines of credit at the time of purchase have fully tapped the amount they can borrow. That approach can overstate the portion of borrowers who are underwater, Mr. Zandi said.

Mr. Humphries of Zillow calls his methodology conservative and said Zillow's use of pricing for individual homes provides a better measure of home valuations than Mr. Zandi's approach, which relies on market-level estimates of home values. He adds that Zillow doesn't include foreclosures in its pricing models.

By RUTH SIMON and JAMES R. HAGERTY of the WSJ follow the link here...  http://online.wsj.com/article/SB124156804522089735.html

On another note...

Mortgage Applications up

The Mortgage Bankers Association (MBA) released its Weekly Mortgage Applications Survey -- a measure of mortgage loan application volume -- for the week ending May 1, 2009, and it showed an increase of 2.4 percent compared with the previous week and 43.7 percent compared with the same week one year earlier. The Refinance Index increased 1.2 percent to 5169.3 from 5108.2 the previous week and the seasonally adjusted Purchase Index increased 5.0 percent to 264.3 from 251.6 one week earlier. The Conventional Purchase Index increased 5.5 percent while the Government Purchase Index (largely FHA) increased 4.4 percent.

The four week moving average for the seasonally adjusted Market Index is down 6.0 percent, the four week moving average is down 3.1 percent for the seasonally adjusted Purchase Index, and down 6.7 percent for the Refinance Index. The refinance share of mortgage activity decreased to 74.4 percent of total applications from 75.3 percent the previous week. The adjustable-rate mortgage (ARM) share of activity remained unchanged at 2.1 percent of total applications from the previous week. Refinance still dominates the mortgage market, but new purchase applications are starting to pick up.

Vacancy leads to declining home prices

The Associated Press conducted an analysis on data from the U.S. Postal Service and Housing and Urban Development, and determined that as of March 31, three percent of U.S. homes had been empty for 90 days or more. Experts say that vacant houses lead to declining property values and falling tax revenues -- as the neighborhoods begin to look increasingly shabby from inattention, there are fewer interested buyers and that leads to more vacancies.

"It becomes a vicious cycle," said Jennifer Vey, a researcher with the Brookings Institution. The ten counties with the most vacancies are: Franklin, Ohio (Columbus); Hamilton, Ohio; Berkeley, S.C. (Charleston); Wayne, N.C. (Goldsboro); El Paso, Colo. (Colorado Springs); Yuba, Calif. (near Sacramento); Cook, Ill. (Chicago); Montgomery, Ohio (Dayton); Marion, Ind.; and Baltimore City, Md.

More "good news" on the job front

Two private reports released today say -you guessed it - the rate of job cuts are slowing. Automatic Data Processing, a payroll-processing firm, said private-sector employment decreased by 491,000 in April, a 31% improvement from the revised 708,000 drop in March, and Challenger, Gray & Christmas Inc. reported that the number of layoffs announced in April shows an improvement of 12% from March's 150,411 cuts. It was the lowest total since last October, according to Challenger, but the April figure was still 47% higher than job cuts announced in the same month a year ago.

John Challenger, chief executive officer of Challenger, Gray & Christmas, said that employers have announced 711,100 job cuts so far this year -- 145% percent higher than the 290,671 job cuts announced in the first quarter of 2008. "Job cuts are still at recession levels, but the fact that they are falling is certainly promising and may suggest that employers are starting to feel a little more confident about future business conditions.

Hopefully, the next few months will bring further relief, as we tend to see downsizing activity slow during the summer months." Joel Prakken, an ADP spokesman and chairman of Macroeconomic Advisers, LLC adds, "There's a sense here of a turn, which is good news," but the job market "is likely to decline for at least several more months, although perhaps not as rapidly as during the last six months."

Stress test -- BOA needs $34 Billion more

The official numbers won't be out till tomorrow, but several news sources report that Bank of America (BOA) needs an additional $34 billion in capital, according to the results of the much ballyhooed "stress test." BOA wouldn't necessarily need to raise $34 billion in new capital, because it can raise the capital by converting the government's preferred share stake into common stock, although doing so would severely dilute the bank's existing common shareholders. Oddly enough, shares rose more than 10 percent on the news, focusing on the importance of getting clarity to the numbers and a sense that BOA could use other means to raise capital that wouldn't necessarily be dilutive to shareholders.
 

Combating the Big Threat of Small Stakes

The new I-Bond rate was recently released for the next six months...the new return is a negative -5.56 percent. Not only did this take many "safe" savers by surprise by wiping out the fixed base-rate of return for nearly all I-bonds released in recent years but it demonstrates one of the most insidious threats facing investors today...the big threat of small stakes.
Consider this, if how much do you need to put into federal bonds to get a meaningful rate of return? With the current negative inflation component, the only benefit to be derived is a return of your primary capital invested...you can't "loose" money at least on paper since you will get the face value of your investment back but even during decent times is the return worth the effort?

Let's assume you are a regular working Joe without a lot of extra money sitting around. You get a fat tax return or bonus now and then plus have a little extra money at the end of each month to invest with...at the end of each year you manage to set aside $5k, !0k or maybe on a good year $20k...at a 5% return that is chump change. Five percent of $5k is only $250 a year and today even that has become tough to get. Five percent of 20k is still only $1,000 or a bit less than $20 per week. Whew...don't spend it all in one place!

But what about stocks? Historically they have delivered a return of 10 percent - if you happen to guess right and are able to consistently time the market. Otherwise you are more likely to join the millions of Americans who have watched their portfolio shrink 20 to 40 percent in recent months...or worse, those that have actually lost money in the market. So, in addition to the risk of your capital...let's assume you are able to retain that 8 percent average on that $5k investment...what do you have to show for it at the end of the year? A whopping $400 pre-tax. Not exactly a life-changing event. Bump it up to reflect your return on $20k to earn $1,600 each year or just over $30 per week prior to paying taxes.

So, what about short sales? If you were to take that same $5k to $20k and sink it into short sales what type of return can you realistically expect to earn. Consider this, many short sale properties are discounted by 20 to 30 percent or even more. You are able to use leverage to purchase properties with a much larger value than you may otherwise qualify for when buying stock on margin (and forget treasury bonds) so even a modest 10 percent return on the entire property can easily lead to 100 percent returns on your out-of-pocket investment. What does this mean in a "real life" situation? Let's assume you are a modest investor starting at a relatively small scale. You put together $5k to make your first modest deal with the goal of doubling your money in 30 days. Essentially you want to buy, fix and sell the property while making only $5k profit then do it again. What happens to your profit if you did just one deal per month...

Month 1 - $5,000 investment and $5,000 profit. Pay back the original $5,000 and re-invest the $5,000 profit. Total out of pocket...zero.

Month 2 - $5,000 investment and $5,000 profit. Total out of pocket...zero. Total profit $10,000

As you can see, within less than three months you can easily generate more profit than a decade's worth of bond or stock investments using very modest means and extremely conservative numbers. Don't fall into the mindset that small returns are safe - nothing is farther from the truth. Small returns are not safe, they are some of the most financially dangerous and risky actions you can take with your hard earned income. Instead, focus your attention on generating enough profit to make a meaningful impact on your budget; whether you pay down a big bill, establish an emergency fund or set aside an income for long term investing short sales provide the leverage, flexibility and returns to make a meaningful contribution to your financial future.