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Underwater Borrowers, Mortgage Defaults Drop Dramatically on Home Price Rise

NEW YORK ( TheStreet) -- The percentage of borrowers who are underwater on their mortgage has improved considerably thanks to the sharp recovery in home prices.

According to the May Mortgage Monitor report from Lender Processing Services, the number of underwater borrowers -- those who owe more than their homes are worth -- dropped by 47% year-over-year in the first quarter to 7.3 million. In 2011, the number of borrowers with "negative equity" was at a high of 17 million. This represents just under 15% of all currently active loans.

Even states deeply affected by the housing bust have seen a sharp improvement. The negative equity rate in Arizona is down 53% to 18.1% in the first quarter of 2013 . In California, the percentage of underwater borrowers is down 51% to 15.6%. In Nevada, the rate fell 49% to 32.7%.

The dramatic drop in the percentage of negative equity loans is important for a couple of reasons.

First, a large percentage of borrowers who are underwater on their mortgage are unable to sell their homes. That is one reason why the supply of existing homes is unusually low right now, despite the recovery in home prices.

As more borrowers are pulled out of water, they can finally come off the sidelines and list their homes.

Second, the drop in underwater loans is also good news for default rates. Underwater borrowers are more likely to walk away from their mortgage. The drop in underwater borrowers therefore has an influence in new problem loan rates.

According to LPS, new problem loan rates are at 0.73%, in line with annual averages in 2005 and 2006 and close to the average 0.55% seen in the 2000-to-2004 period.

With the decline in new problem loan rates and as more problem loans work their way through the system (short sales, foreclosures and so on) national delinquency rates have dropped. In the first quarter, the delinquency rate declined by 15% from the end of December 2012 to 6.08%.

This is still about 1.4 times higher than the average default rate in the pre-bubble days. But it was the largest year-to-date drop in 11 years, according to LPS.

-- Written by Shanthi Bharatwaj in New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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