Rate Resets to Spell Trouble for Underwater Borrowers

While the country's negative equity rate has continued to improve—albeit at a slower pace in recent months—the picture looks very different for modified loans, Black Knight Financial Services says in its latest Mortgage Monitor Report.

Based on mortgage performance data as of the end of April, Black Knight noted there are approximately 2 million modified mortgages due for mortgage rate resets in the coming years. With the economic recovery still hobbling along, the company estimates more than 40 percent of that group remain underwater.

In addition, another 18 percent of modified borrowers have 9 percent equity or less in their homes, putting them perilously close to sinking back under and spelling potential trouble ahead, says Kostya Gradushy, Black Knight's manager of loan data and customer analytics.

"Given that the data has shown quite clearly that equity—or the lack thereof—is one of the primary drivers of mortgage defaults, these resets may indeed pose an increased risk in the years ahead," Gradushy said.

Including all borrowers, Black Knight estimates the national negative equity rate is 9.4 percent, with an additional 10 percent in 'near negative equity,' meaning the borrower has less than 10 percent equity in their home. Not only are those borrowers "hovering at the edges," as Gradushy says, but with so little equity, most wouldn't profit enough from selling their home to cover the costs of buying a new one.

Among other findings, Black Knight also noted mortgage prepayment rates—which historically have served as a good indicator for refinance activity—increased for the second straight month in April as interest rates hover lower than they were at the end of 2013.

Of note: Adjustable-rate mortgages with interest rates below 6 percent prepaid at greater speeds than fixed-rate mortgages, suggesting "concerns about rising interest rates persist among the borrower population, despite the recent pullback in 30-year conforming rates," the company said.