Since the housing market unraveled in 2008, lenders have slashed the interest rates on millions of mortgages belonging to struggling borrowers — but only for a limited time.
And for about 2 million of the loans, that time is up, or soon will be.
Starting this year, the rates will begin to gradually rise on those mortgages, and it's unclear if the homeowners will be able to handle the higher payments, according to an analysis released Monday by Black Knight Financial Services, a mortgage research firm.
Roughly 40 percent of the loans belong to borrowers who are "underwater," meaning they owe more on their mortgages than their homes are worth, the analysis said. Those borrowers therefore can't sell their properties or refinance if they run into financial trouble once the higher rates kick in, which increases their chances of defaulting on their loans.
"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," Kostya Gradushy, Black Knight's manager of loan data and customer analytics, said in a statement.
The analysis does not provide any estimates on how much more the 2 million borrowers would have to pay once their interest rates reset, or how many of them are likely to default. The firm studied loan modifications made from 2008 through 2013, both through government initiatives and programs developed by individual lenders.
Regulators and consumer advocates have voiced concerns about the most prominent of the government's efforts: the Home Affordable Loan Modification Program (HAMP).
About 800,000 borrowers who remain enrolled in HAMP will see their rates gradually rise starting this year, eventually increasing payments by more than $1,000 a month in some cases, according to a report released earlier this year by the special inspector general for the Troubled Asset Relief Program.
Housing experts have warned that many of these borrowers may not be much more financially stable now than they were when they initially turned to the government for help. The federal initiative was based on the assumption that the economy would bounce back more quickly, undoing the damage wrought by plunging home prices and high unemployment. But the average household income has been flat for all but the highest earners since the program launched in 2009.
Most of the HAMP borrowers had their interest rates cut for five years, some to levels as low as 2 percent, so that their mortgage payments did not exceed 31 percent of their gross monthly income. After five years, the rates are supposed to rise by up to a full percentage point a year until they reach whatever the average interest rate was for a 30-year fixed-rate mortgage at the time the loan was modified.
A report last month by the Urban Institute concluded that most HAMP borrowers whose loans were modified in 2009 will be able to cope with the first two payment jumps. The third payment increases, however, "may prove problematic," the report said. And the first substantial defaults should take place in 2016, and pick up the following year.
Still, the report concluded that fears of massive redefaults are overblown in part because the rate adjustments will be taking place in a healthier housing market, and because some borrowers are likely to strike deals with lenders that will keep their rates low.
Still, even borrowers who did not get their loans reworked through a federal program or any other initiative face potential challenges, Black Knight concluded in its analysis.
Aside from underwater borrowers, the company focused on homeowners who are almost underwater — with less than 10 percent equity in their homes. It found that about one of every 10 borrowers fall into that bucket based on the company's own price index, which tracks the repeat sales of homes in more than 19,000 Zip codes nationwide.
Those who are nearly underwater are susceptible to even slight changes in prices, Gradushy said in an interview.
In the Fort Hood, Texas, region, a quarter of a percent drop in home prices from December through February increased the number of underwater loans there by 20 percent, Gradushy said. A 0.02 percent price decline in the area around Little Rock, Arkansas in February resulted in a nearly 12 percent increase in underwater borrowers in that region.
Even if borrowers are not technically underwater, those who have very little equity in their homes will most likely have to bring cash to the table if they decide to sell their homes just to cover the commissions of the real estate agents involved in the deal, Gradushy said.
"So even if your house is worth exactly what you owe on your mortgage, you are still technically underwater," Gradushy said.