Maggie Medved was stuck with her Phoenix house for two years after the market crash wiped out the equity in the property. Last year, as prices in the area rose by the most in the U.S., she and her partner were finally able to sell the 3-bedroom 1950’s style home and move to a larger place.

“We were counting the days for when we could move,” said Medved, 40, who trains employees for weight loss company Jenny Craig Inc. “We definitely knew it was a waiting game because it would’ve been financial suicide if we had sold earlier.”

Medved was among the 12 million borrowers in the U.S. who at the peak of the real-estate downturn owed more on their mortgages than their houses were worth, blocking them from moving or saving money by taking advantage of the lowest borrowing costs on record to refinance. As prices recovered, the number of underwater borrowers fell by almost 4 million last year to 7 million, according to JPMorgan Chase & Co., and could drop to 4 million within 2 years.

The housing market is rebounding faster than anyone thought possible, according to Blackstone Group LP’s global head of real estate Jonathan Gray, as the Federal Reserve buys mortgage bonds to keep rates near record lows and investors sop up a diminishing supply of properties for sale. Housing construction could boost U.S. gross domestic product by 0.4 percentage point and home price appreciation may add another 0.2 percentage point, Bank of America Corp.’s senior economist Michelle Meyer forecasts.

‘Appreciating Asset’

“It supports household wealth, consumer confidence and can generate greater credit creation,” Meyer said. “If prices are rising, homeowners believe that they will once again have an appreciating asset. It’s a very big change in how they think about their wealth and their balance sheets.”

Medved’s Phoenix home was on the market for two days before it sold for $85,000, just shy of the price paid in 1998. She and her partner Wendy Thomas bought a larger property with a pool for $210,000 in Glendale, about 10 minutes away.

“We’d outgrown the house and the neighborhood took a turn we didn’t like,” Medved said. “Almost 12 years later we were in the hole $30,000. We couldn’t take that much of a loss and needed to stay regardless of what the neighborhood had become.”

Arizona’s capital city is leading the U.S. in price appreciation, surging 22 percent in the 12 months through October, according to an S&P/Case-Shiller index, which had the biggest year-over-year advance since May 2010. Eighteen of the 20 cities in the index showed increases from a year earlier.

Even with the gains, Phoenix prices were down about 45 percent through November from their 2006 peak, according to Zillow Inc. Nationally, prices peaked in May 2007, according to the real-estate website, and are down 19 percent.

Supply Dropping

Prices of properties in Phoenix climbed as the inventory of houses for sale dropped to about 14,700 in December, about half of the normal level, according to Tina Waggoner, a real estate broker in Phoenix, and the one who sold Medved’s property last year.

“The supply has dropped substantially,” said Waggoner, who specializes in distressed sales. “Cash investors are beating out buyers all the time.”

JPMorgan analysts led by John Sim estimate the price growth last year was responsible for a drop of almost 4 million in underwater borrowers. The number of homeowners that owe more on their mortgages than their properties are worth may fall to 4 million by the end of 2015, according to Sim, whose team is the top-ranked for residential mortgage securities in Institutional Investor magazine’s annual survey.

Constrained Inventory

While a 5 percent increase in home prices could lower the number of underwater borrowers to just above 5 million, a move of that magnitude in the other direction would push it back over 10 million, he wrote in the Jan. 4 report.

Supply across the country is being been constrained as institutional investors including Blackstone and Colony Capital LLC have pushed out traditional buyers competing for a dwindling number of properties.

Blackstone, the largest U.S. private real estate owner, has accelerated purchases of single-family homes as prices jumped faster than it expected, spending more than $2.5 billion on 16,000 homes to manage as rentals, Gray said during an interview last week. That’s up from $1 billion of homes owned in October, when Blackstone Chairman Stephen Schwarzman said the company was spending $100 million a week on houses.

Underwater borrowers, who can’t sell without taking a loss, contributed to rising levels of foreclosures, which blighted neighborhood prices by increasing the number of abandoned homes. It also increased the phenomenon of borrowers who saw little chance of their homes ever being worth what they owed on it sending the keys back to the bank and moving out, known as strategic default.

Foreclosures Slowing

Foreclosure starts dropped 28 percent in November from a year earlier, data provider Lender Processing Services Inc. wrote in a report this week.

As real estate prices rise further, more homeowners will emerge from negative equity and may decide to sell, adding to supply.

Still, increasing prices will have a more gradual effect on the housing market, said Karen Weaver, head of market strategy and research at investment firm Seer Capital Management LP in New York. “Home prices are not rocketing up,” said Weaver. “But all the trends are in place. You have an improvement in the negative equity situation and you have a reduction in the amount of people in the default bucket.”

Housing Estimates

Home values climbed by more than $1.3 trillion to $23.7 trillion since the end of 2011, according to Zillow, and prices will rise by 3.3 percent after an estimated 4.5 percent jump last year, based on estimates of 15 economists and housing analysts surveyed by Bloomberg. Sales of existing homes will increase about 7.2 percent in 2013 to 4.98 million, the highest since 2007.

Increasing prices compounded with Fed efforts to keep mortgage rates low could widen the population of borrowers eligible to refinance and have implications for bond investors.

Higher levels of refinancing would be a boon for securities without government backing such as subprime bonds and option adjustable-rate mortgages issued during the housing boom that trade at discounts to par. Faster prepayments could hurt holders of government-backed mortgage bonds, whose prices average almost 108 cents on the dollar, according to Bank of America data.

The improving housing market has already helped the broader economy heal after the crash triggered the worst recession since the Great Depression. The unemployment rate has dropped to 7.8 percent, the lowest level since January 2009 and Fed officials in December projected economic growth in a range of 2 percent to 3.2 percent in 2013.

“For most middle class households, homes are by far their biggest asset,” Weaver said. “So once the housing market starts to recover it helps consumer spending, it helps the whole economy.”