1 in 37 homeowners hold mortgages that are much higher than the market value of their homes, a new study finds.

According to real estate data firm ATTOM, 2.7% of U.S. mortgages are "underwater"—meaning the principal is at least 25% higher than the home market value.

Although a slight increase from 2.6% in the previous quarter, it's still well below the pre-pandemic level when about 6.6% of mortgages were underwater.

The rise in underwater mortgages is due to a 4% decline in home prices since the winter.

“When prices flatten out or drop, equity usually follows even as homeowners pay off mortgages,” said ATTOM’s CEO Rob Barber.

Barber thinks this slowdown isn't temporary. “The windfalls are starting to erode bit by bit amid mounting signs that the market is no longer super-heated,” he said.

"This year’s spring buying season will be of heightened importance in telling us if there is a new long-term market pattern developing.”

An underwater mortgage, also known as an upside-down mortgage, is a residential loan with a higher principal than the home’s worth.

This happens when a home’s value declines, but the owner is still on the hook for the original principal.

Since the fourth quarter of 2022, home prices have been in decline, meaning homeowners have been losing equity this whole time.

High interest rates crush housing demand

Toward the end of last year, economists predicted a strong 2024 for housing, assuming the Fed would cut states and mortgage rates would follow.

That scenario didn't materialize as expected.

Following the surprising uptick in inflation, mortgage rates have re-accelerated this year, pushing toward 8% in some parts of the country.

Wall Street thinks higher rates are here to stay because the economy is still too strong.

“What you have right now is a situation where these high rates aren’t generating more braking power on the economy,” said Joseph Lupton, global economist at JPMorgan.

“That would suggest that they either need to stay high for longer or maybe even higher for longer.”

According to data from the Mortgage Bankers Association (MBA), mortgage applications have declined in nine of 18 weeks this year up to May 3.

This included painful drops of 7% or more on multiple occasions.

Freddie Mac chief economist Sam Khater believes the housing market will remain under significant pressure so long as rates hover above 7%.

“Many potential sellers remain hesitant to list their home and part with lower mortgage rates from years prior, adversely impacting supply and keeping house prices elevated,” Khater said.

Realtor.com economist Jiayi Xu seconds Khater, predicting “a slow spring, characterized by fewer transactions.”